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Foreign direct investment in the Japanese and Korean banking sectors Ursacki, Terry 1990

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F O R E I G N D I R E C T I N V E S T M E N T IN T H E J A P A N E S E A N D K O R E A N B A N K I N G S E C T O R S by Terry Ursacki B.A., Laurentian University, 1980 M.B.A. , University of British Columbia, 1982 A THESIS S U B M I T T E D IN P A R T I A L F U L F I L L M E N T O F T H E R E Q U I R E M E N T S F O R T H E D E G R E E O F D O C T O R O F P H I L O S O P H Y in T H E F A C U L T Y O F G R A D U A T E STUDIES (Commerce and Business Administration) We accept this thesis as conforming to the required standard T H E UNIVERSITY O F BRITISH C O L U M B I A November 1990 0 Terry Ursacki, 1990 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Faculty XBHJ&lffittfJemC of Commerce and Business Administration The University of British Columbia Vancouver, Canada DE-6 (2/88) ii A B S T R A C T Foreign direct investment (FDI) in banking (i.e., the establishment of branches, representative offices, agencies, subsidiaries, or affiliates abroad) is one of the key features of the international monetary system, yet it has received relatively little attention, particularly from empirical researchers. This thesis first reviews the existing work on FDI in banking, and then proposes a theoretical framework for understanding the sources of competitive advantage which lead to multinational banking. This framework integrates earlier work on the theory of financial intermediation with Durming's eclectic theory of FDI. Sources of competitive advantage (Dunning's "ownership-specific advantages") are found to lie in the areas of transaction cost reduction, asset transformation, information production, monitoring, and signalling. Empirical proxies for these variables are then identified. The importance of these variables is then tested using data on foreign banks operating in Japan and Korea. The first test uses survival time analysis (Cox proportional hazards model) to identify the factors associated with early entry into these markets after they were opened to foreign banks. The second uses multinomial logit analysis to examine the factors distinguishing banks which have established a branch or representative office in Japan and Korea from those that have not. The results of the two models are consistent for the most part and are generally in accordance with the predictions of the theory. The final part of the thesis explores the reasons for the strategic choices of the foreign banks in these markets and their relative success in implementing them. A cluster analysis reveals the presence of strategic groups in each market whose membership is broadly consistent with the types of advantages they have, as revealed by a review of the trade press. The most profitable foreign banks are found to be those that pursue niches with high barriers to entry, usually due to a natural advantage such as nationality. Implications for further research are then discussed. iii Table of Contents Page Abstract ii List of Tables v List of Figures viii Glossary ix Chapter 1 - Introduction 1 1.1 Background 1 1.2 Foreign Direct Investment in Banking: A Puzzle? 3 1.3 The Selection of Japan and Korea 5 1.4 Contribution 7 1.5 Plan of the Thesis 12 Chapter 2 - Theory 13 2.0 Introduction 13 2.1 Dunning's Eclectic Framework 13 2.2 Applying the Eclectic Framework to Multinational Banking 15 2.2.1 The Nature of the Industry: Identifying the Key Ownership-Specific Advantages in Banking and the Incentives for Their Internalization 15 2.2.2.1 Transactions Costs and Diversification 17 2.2.2.2 Asset Transformation 22 2.2.2.3 Information Production and Signalling 25 2.2.2.4 Monitoring 36 2.2.2.5 Ownership-Specific Advantages and the Technology of Banking 39 2.2.3 Location-Specific Advantages 44 2.2.3.0 Introduction 44 2.2.3.1 Large and Growing Markets 45 2.2.3.2 Cost of Immobile Inputs 47 2.2.3.3 Regulation 48 2.2.3.4 Information and Communication Costs 53 2.2.3.5 Signalling 57 2.2.4 Network Economies: The Interaction of Ownership- and Location-Specific Advantages 61 2.2.5 Summary 66 iv Table of Contents - continued Chapter 3 - Methodology 70 3.1 Introduction 70 3.2 The Timing of Entry 71 3.3 Forms of Entry 77 3.4 Post-Entry Competition 81 3.5 Data 89 3.5.1 The Samples 89 , 3.5.2 The Variables 92 3.6 Foreign Banks and the Japanese Banking Market 96 3.7 Foreign Banks and the Korean Banking Market 99 3.8 Hypotheses 105 Chapter 4 - Results 110 4.1 Model I (Survival Time) Analysis 110 4.1.0 Introduction 110 4.1.1 Japan 111 4.1.2 Korea 114 4.2 Model II (Multinomial Logit) Analysis 115 4.2.0 Introduction 115 4.2.1 . Japan 116 4.2.2 Korea 119 4.3 Post-Entry Competition 122 4.3.0 Introduction 122 4.3.1 Japan 122 4.3.2 Korea 139 4.3.3 Conclusions from Post-Entry Competition Analysis 146 Chapter 5 - Conclusions 151 Bibliography 154 Tables and Figures 175 V List of Tables Table 1-1 Global Network of Overseas Branches and Agencies: 1978 vs. 1961 Table 1-2 Foreign Network of the World's 100 Largest Banks, 1985 Table 1-3 Summary of Major Categories of Variables Found Significant at the 95% Level in Empirical Studies of Multinational Banking Table 2-1 Dunning's Eclectic Framework Table 3-1 Independent Variables: Definitions and Sources Table 3-2 Foreign Bank Branch Opening Chronology: Post WWII Japan Table 3-3 Shares of Total Employable Funds by Type of Financial Institution, Japan, 1955-80 (%) Table 3-4 The Rise of Japanese Banks, 1979-1988 Table 3-5 Market Share of Foreign Banks in Japan, 1971-76 Table 3-6 Profitability and Growth of Foreign Banks in Japan, 1972-79 Table 3-7 Profitability of the Foreign Bank Sector in Japan, 1983-89 Table 3-8 Comparative Profitability of the Japanese Banking Sector, 1980-84 Table 3-9 Market Shares of Financial Institutions in Japan, 1986 Table 3-10 The Growing Importance of Extraordinary Profits in Foreign Bank Results in Japan, 1983-89 Table 3-11 The World's Top 25 Banks by Extent of Geographical Diversification, 1979-86 Table 3-12 The Growing International Use of the Yen Table 3-13 Foreign Bank Branch Opening Chronology: Post WWII Korea Table 3-14 Deposit Money Bank Assets by Type of Bank, Korea, 1975-1981 Table 3-15 Deposit Money Bank Loans and Deposits by Type of Bank, Korea, 1985-1987 Table 3-16 Korean Banks in the Top 500 by Assets, 1979-88 List of Tables - continued vi Table 3-17 Geographical Diversification of Korean Banks, 1979-86 Table 3-18 Importance of Head Office Transfers as a Source of Funding for Foreign Bank Branches in Korea, 1975-1988 Table 3-19 Foreign Banks' Market Share by Type of Banking Business, Korea, 1977-1988 Table 3-20 Profitability of the Korean Banking Sector, 1968-1982 Table 3-21 Profitability of Foreign Banks in Korea, 1983-88 Table 3-22 Trends in Korean Overseas Investment Table 3-23 Japan's Private Foreign Capital Stock, 1960-84 Table 3-24 Stock of Foreign Direct Investment in Japan by Country, 1985-88 Table 3-25 Foreign Investment in Korea by Year Table 3-26 Foreign Investment in Korea by Country (Approval Basis) Table 3-27 Stock of Foreign Direct Investment in Korea by Industry, 1986 Table 3-28 Korea's Foreign Debt Table 4-1 Model I (Survival Time) Results Table 4-2 Model II (Multinomial Logit) Results Table 4-3 Model II (Multinomial Logit) Average Elasticities Table 4-4 1979 Cluster Analysis: Japan Table 4-5 1983 Cluster Analysis: Japan Table 4-6 1986 Cluster Analysis: Japan Table 4-7 1989 Cluster Analysis: Japan Table 4-8 Variable Means by Cluster for Japan, 1979-89 Table 4-9 Ten Largest Foreign Bank Branches in Japan by Total Assets, 1979-1989 List of Tables - continued vii Table 4-10 The Twenty Foreign Bank Branches in Japan with the Lowest Branch Assets per Employee, 1986 Table 4-11 Most Profitable Foreign Banks in Japan by R O A , 1983-1989 Table 4-12 Characteristics of Korean Banks in Japan Table 4-13 Foreign Bank Branches in Japan Which Were Net Suppliers of Funds to Their Head Offices Table 4-14 1983 Cluster Analysis: Korea Table 4-15 1986 Cluster Analysis: Korea Table 4-16 1988 Cluster Analysis: Korea Table 4-17 Variable Means by Cluster: Korea Table 4-18 Top 10 Foreign Banks in Korea by Reliance on Loans, 1983-1988 Table 4-19 Top 10 Foreign Banks in Korea by Reliance on Head Office Funding, 1983-1988 Table 4-20 Top 10 Foreign Banks in Korea by Assets per Employee, 1986 Table 4-21 Profitability of Foreign Banks in High Loans Clusters in Korea, 1983-1988 Table 4-22 Top 10 Foreign Banks in Korea by Total Assets, 1983-1988 List of Figures Figure 3-1 Foreign Banks in Japan: Cumulative Total Net of Exits Figure 3-2 Financial Institutions in Japan Figure 3-3 Foreign Banks in Korea: Cumulative Total Net of Exits Figure 3-4 Financial Institutions in Korea Figure 4-1 Summary of Cluster Analysis for Japan, 1979-1989 Figure 4-2 Foreign Bank Loans and Discounts in Japan by Country, 1979-1989 Figure 4-3 Summary of Cluster Analysis for Korea, 1983-1988 Figure 4-4 Foreign Bank Loans and Discounts in Korea by Country, 1983-1988 ix Glossary triple A credit rating, the highest attainable. Assigned by a credit rating agency. commitment to pay a draft (order to pay), signified by writing or stamping " A C C E P T E D " on the draft and signing it separately incorporated foreign operation in which the parent has an ownership stake insufficient to ensure control (cf. subsidary) integral part of a bank (not separately incorporated). Essentially limited to lending operations (i.e., no active deposit taking). Almost exclusively found in the U.S. (cf. branch). Australia New Zealand (Bank) bank's total assets less contra items automated teller machine Bank of Credit and Commerce International Bank for International Settlements The Bank of Nova Scotia Bank of Japan (central bank) Bank of Korea (central bank) integral part of a bank (not separately incorporated). Subject to local laws, may undertake both lending and depository activities (cf. agency) capitahassets ratio (capital divided by assets less contras) certificate of deposit, i.e., fixed term deposit top-tier of commercial banks in Japan, headquartered in major cities and with (limited) branches throughout Japan draft (order to pay) sent by an exporter through his bank to his bank's correspondent in the importer's country. The correspondent presents it to the importer for acceptance or payment. Can be clean (without additional documents) or documentary (accompanied by documents which the importer needs to clear the goods through customs, documents which are to be released by the bank only upon acceptance or payment of the draft) (see acceptance) C O M M P C T C O U N T R I E S D E P D M B E B A Eurobonds Eurocurrency E X P E R T I S E FDI FINPCT G T E E H O H Q L A T A IFC ILO impact loans Glossary - continued percentage of the home labour force employed in the commerce sector number of foreign countries in which the bank has a branch, agency, representative office, or commercial banking subsidiary or affiliate deposits/branch assets in host country deposit money bank amount of Eurobonds lead managed, 1963-67, normalized for the bank's size bonds issued outside the country in whose currency they are denominated currency deposited outside its country of issue (e.g., Eurodollars are U S dollars deposited outside the U.S.). Traded in Euromarkets. average market share 1979-1983 in foreign exchange trading and lead management of syndicated loans and Eurobond issuance, normalized for the bank's size foreign direct investment, i.e., investment held in a foreign enterprise which confers control percentage of the home labour force employed in the financial sector customer liability under guarantees and acceptances/branch assets in host country (liabilities to head office and affiliates - due from head office and affiliates)/branch assets in the host country headquarters International Air Transport Association international financial centre International Labour Organization foreign currency loans made to Japanese borrowers by financial institutions (esp. foreign banks) in Japan. Mostly medium-term (two to five years). I M P O R T S home country imports from the host country XI Glossary - continued J E T R O JFDI K F D I L D C letter of credit leveraged buyout (LBO) L O A N L S A M N B M N C M O F national treatment NBP NIC O E C D O P E N O S A P ( ) Japan External Trade Organization stock of foreign direct investment by companies from the bank's home country in Japan stock of foreign direct investment by companies from the bank's home country in Korea less developed country conditional guarantee by an importer's bank that payment will be made to the exporter if certain documents are presented arrangement whereby a management group takes over its former employer by borrowing heavily, using the company's assets and personal guarantees as security loans and discounts/branch assets in the host country location-specific advantage multinational bank (i.e., a bank with at least one office overseas) multinational corporation Ministry of Finance policy of treating foreign banks the same as domestic banks National Bank of Pakistan newly industrialized country (an L D C which has achieved middle income status through industrialization, such as Korea or Taiwan) Organization for Economic Cooperation and Development dummy variable which equals one if reciprocity exists, zero otherwise ownership-specific advantage Probability that ( ) xii P R C reciprocity R E N T representative office (rep office) R O A R O E SAIRDIST S E C sogo shosha subsidiary Glossary - continued People's Republic of China policy of allowing the establishment of branches by country A's banks in your country only if A allows your country's banks to establish branches in A rent in US dollars per month for a four room luxury apartment of the quality usually provided for expatriate staff integral part of a bank (not separately incorporated). Can solicit business for booking overseas, but cannot conduct any banking business on the host country's soil (cf. branch). return on assets return on equity air distance from bank's headquarters to Seoul in nautical miles holdings of securities/branch assets in the host country major Japanese trading company separately incorporated foreign operation which is controlled by the parent (cf. affiliate) swap transaction arrangement whereby foreign banks deposited foreign currency with the central bank of a host country and in return received local currency under conditions that limited or eliminated foreign exchange risk. Also, the exchange of one financial asset for another (e.g., a fixed interest rate liability for a floating rate one). TAIRDIST air distance from bank's headquarters to Tokyo in nautical miles T D Toronto Dominion Bank T R A D E sum of home country exports to and imports from the host W W I World War I W W II World War II zaiteku Japanese term meaning "financial engineering," i.e., the practice of non-financial corporations using surplus or borrowed funds for active financial speculation 1 Chapter One I N T R O D U C T I O N 1.1 Background Multinational banking, i.e., the establishment by a bank of offices, subsidiaries, or affiliates in other countries, has been in existence for many hundreds of years. In the early fifteenth century, for example, dissatisfaction with correspondent and agent relationships led the Medicis of Florence to open branches in Bruges and London, supplementing existing offices in Basel and Geneva (de Roover, pp. 317-321). The colonial expansion of the latter half of the nineteenth century, however, gave multinational banking its first great impetus, as many "overseas" banks arose to meet the banking needs of colonists and merchants. By the beginning of this century, British, French, Dutch and German colonial banks operated over 2,300 overseas branches (Vollmer, 1974, p. 139). This growth phase was interrupted by WWI, and then reversed by the Great Depression, when worldwide economic collapse forced banks to abandon many of their overseas operations. The number of American banks with offices abroad, for example, dropped 60% from 20 to eight (Yannopoulos, 1983). The post WWII era once again saw banks moving overseas, but still on a relatively small scale. It was only in the 1960s and 1970s that a headlong rush to blanket the globe with branches, representative offices, subsidiaries and affiliates began. As can be seen in Table 1-1, from 1961 to 1978 the total number of foreign bank branches and agencies in the world (excluding Africa)1 more than doubled from 1,860 to 4,080 (Pecchioli, 1983, 1. In Africa the loss of the British and French colonial empires resulted in a reduction of over 2,200 in the number of foreign-owned branches. Most of these, however, were taken over by locally incorporated subsidiaries or affiliates under slightly changed names. 2 p. 59). Bank advertisements of the era frequently emphasized the new and often exotic locations in which they were now pursuing business (see, for example, Schull and Gibson, 1982, pp. 247, 254; Bankers' Almanac. 1966-67, p. G233). This trend changed abruptly when the L D C debt crisis began to emerge. With major international banks saddled by the vast sums they had tied up in loans to countries that might never repay them, being a homebody was suddenly in fashion again. Many banks withdrew from international lending altogether and those that had established overseas branch networks began to rationalize, pruning the less important or lucrative markets (see, e.g., Financial Post. May 29, 1989, p. 8). U.S. banks in particular tended to reduce their overseas presence (Time. May 21, 1990, p. 38). This tendency may have been reinforced by technological progress, since "the need for foreign offices was also diminished by advances in telecommunications and information technology" (United Nations, 1988, p. 102). Yet new offices have been opened in countries such as Canada, Australia, Spain and Sweden as the world-wide trend towards deregulation offers up new opportunities. Thus, it may be more accurate to describe today's trend as one of realignment rather than retrenchment. While a complete survey of the world's banks has not been undertaken, Table 1-2 shows that the number of foreign offices of the world's 100 largest banks actually increased by 148 to 4,660 from 1980 to 1985. Fragmentary evidence suggests the networks of smaller banks have also increased, probably more rapidly (United Nations, 1988, p. 113). Modern multinational banking has proven itself to be a durable phenomenon, even in the face of turbulence and adversity. But what can we learn through its study? Does research on the topic hold out the prospect of learning something of broader applicability? 3 1.2 Foreign Direct Investment (FDI) in Banking: A Puzzle? To the casual observer, the prevalence of FDI in banking may appear perplexing. Why should banks find it desirable to establish operations overseas? There is little or no patentable technology to exploit; the product most frequently associated with banks (money) is widely regarded as a commodity traded in near-perfect markets and can be "shipped" with nominal "transport" costs; and no country has a monopoly on the raw material in the way some mineral-rich hosts to FDI do. What is even more curious, we can observe French banks lending money in the U.S. and U.S. banks lending money in France. Why would two countries simultaneously be lending each other money? Of course, these questions are naive, yet even more sophisticated observers (e.g., Dale, 1984) have argued that without government intervention (i.e., regulation), there would be little need for multinational banks. However, in reality the very nature of the borrowing and lending process creates the types of market failure that so often result in a need for a bank to operate overseas if it is to preserve its ability to resolve them. Banking is essentially a high volume, low margin business: whether making a loan, processing a payment, or taking a foreign exchange position, the fraction of a transaction that goes to a bank is quite small, and after deduction of direct expenses, often minuscule. Thus, errors are extremely costly: if one makes a $1,000 bad loan, one must lend $200,000 (at a net margin of one half of a percentage point) simply to recoup the lost principal. As a result, information is critical in the banking industry. Bankers must know far more about their customers (including other banks) than most vendors for they must not only learn their needs, but also predict how they will care for the product once it has been "purchased." Yet much of the information banks must evaluate is provided by potential borrowers themselves, and in some cases these borrowers may face strong 4 incentives to misrepresent themselves. Borrowers, too, need to make careful judgments about their dealings with banks, for they are typically of a long-term and very vital nature. Just as construction companies must be able to depend on their equipment suppliers for reliable parts replacement and repair service over many years to prevent costly interruptions which could result in missed deadlines, so too must bank clients be able to rest easy knowing that their financial supplier(s) will be there when needed. The need for profitable outlets for funds, however, provides strong incentives for banks to misrepresent the extent to which they possess these desirable characteristics. Similarly, the need to obtain low cost funds has often led banks to overstate their creditworthiness to depositors. Given these asymmetric information problems between borrowers and lenders, questions of signalling and optimal techniques for obtaining and processing information are particularly germane to the success of a bank in resolving them. 2 , 3 Transactions in banking technology are also subject to market failure problems. Precisely because of the lack of patent or copyright protection on most banking innovations, individual innovators would be constrained from exploiting them through licensing in the way that, say, the inventor of a new machine might. Without any legal protection and no tangible product to sell, financial innovations 2. While investors in overseas markets almost inevitably face asymmetric information problems such as those described here, these problems are more severe for banks than, for example, mutual funds. The latter typically invest in shares or other instruments which are widely traded in more or less efficient markets and can benefit from the market's collective wisdom as to the value of an investment in a company. Even when a bank extends credit to a company with traded shares, its "investment" is almost always substantially less liquid and frequently has unique features detailed in loan covenants, etc. which make direct comparisons with traded instruments difficult. The literature on how banks help to resolve asymmetric information problems will be reviewed in Chapter Two. 3. As Dahlman (1979) has pointed out, "institutions fulfill an economic function by reducing transaction costs" such as those due to imperfect information (p. 161). 5 would be, in Weimer and Vining's (1989) terminology, nonrivalrous, nonexcludable, and uncongested, and hence a true "pure public good."4 They would thus not be produced in adequate quantity, if at all. By taking advantage of labour market rigidities, banks can hire people to innovate and keep them long enough to earn a return on their investment in innovation through an increased return on their portfolio. Because banking puts these questions in such sharp focus, the insights we gain by studying how banks cope with them can be instructive to those in other service industries. 1.3 The Selection of Japan and Korea This study focuses on foreign banks in Japan and Korea, asking such questions as: (a) Why do some banks enter markets early, others late, and still others not at all? (b) Why do some banks choose one type of representation and others another? and (c) What influences the performance of banks which enter a given market? These host markets were chosen for several reasons. The two countries share many similarities: both are small, densely populated nations which have made relatively late and very rapid transitions from agrarian to industrialized societies. Many observers have ascribed a large part of their success to astute government industrial policies, 4. Nonrivalrous means that one person's consumption does not impair others' ability to consume the same good. Nonexcludable means that one cannot control who has access to the good once it is on the market (as soon as one person bought the innovation, he could give it away to all comers, depriving the innovator of any return). Uncongested means that demand is low enough relative to supply that one person's consumption does not reduce the ability of others to use the good (see Weimer and Vining, 1989, p. 40). 6 policies in which the countries' banks- both domestic and foreign-have played a key role. Yet in terms of the foreign bank sector they offer many interesting contrasts. Tokyo is an international financial centre of the first rank, while Seoul's international role is negligible (Reed, 1984). Japan boasts most of the world's largest and most powerful banks, while those in Korea are quite small and weak. Foreign banks have had to accept absurdly low returns to gain even a modest toehold in the enormous yet highly competitive Japanese market, while in Korea they have earned comfortable margins on a much larger share of the small Korean market.5 These countries, then, can be viewed as representative of two broad classes of markets, the international financial centres and the small protected domestic financial centres, which together comprise a very large proportion of the world's nations. The findings of this study should therefore have significance beyond the specific markets chosen. From a practical standpoint, too, Japan and Korea offer major advantages. Throughout most of the period under study (1979-89) both Japan and Korea had relatively compartmentalized banking systems which kept banking largely separate from other financial activities (e.g., underwriting securities). Thus, it is reasonable to talk about the commercial banking market in relative isolation from other financial industries. In addition, unlike most countries, they require foreign banks to publish financial statements on their branch operations. While one must always exercise care in the use of such data, they offer an intriguing glimpse into activities which are normally fully shielded from public scrutiny. 5. Additional detail on the performance of foreign banks in the two countries will be introduced in Section 4.3. 7 1.4 Contribution Theories of foreign direct investment (FDI) are essentially concerned with market entry. The fundamental question they seek to answer is what causes a corporation to establish production facilities (in the broadest sense) in a country other than that in which it is headquartered. Typically, however, empirical tests of FDI theories have attempted to identify factors associated with size (measured by volume of FDI) 6 or performance (usually profits)7 of multinational corporations (MNCs). Others (e.g., Grubaugh, 1987) examine characteristics correlated with multinationality without reference to the location of the investments. Studies looking at entry into specific markets (e.g., Terpstra and Yu, 1987; Y u and Ito, 1988) are the exception. The literature on multinational banking has followed this trend, examining either size measures such as loans, deposits or assets,8 performance measures such as profits, R O A or R O E (e.g., Giddy, 1983) or both (e.g., Fieleke, 1979; Cho, 1985). The logical link between the entry orientation of the theory and the size and performance orientation of the empirical literature has been the observation that since foreigners face higher costs of doing business in an overseas market, they must have some offsetting advantage to enable them to compete with local businesses, which have superior knowledge of the host country's culture, politics, etc. (Hymer, 1976). If MNCs do indeed have such an advantage, then, so the reasoning goes, surely it should show up in their growth and performance. Thus, underlying most empirical studies is essentially 6. e.g., Kim et al., 1989; Nigh, 1985; Fatehi-Sedeh and Safizadeh, 1988; Sleuwaegen, 1985. 7. e.g., Tallman, 1988; Benvignati, 1987; Lecraw, 1983. 8. e.g., Terrell, 1979; Goldberg and Saunders, 1980; Khoury, 1980; Nigh et al., 1986; Goldberg, Helsley and Levi, 1987; Sabi, 1988. 8 a search for this "factor X" which makes MNCs more profitable.9 Again the banking literature parallels work on the more general M N C problem, with both multi-host studies10 and those focussed on a single market.11 Regrettably, data limitations have forced most of this work to concentrate only on U.S. banks abroad,12 foreign banks in the U.S. 1 3 or both.14 One major contribution of this study is that it is the first which looks at the behaviour of banks from multiple home countries in individual host countries other than the U.S.. Evidence on the behaviour of non-U.S. banks is of increasing interest given the decline in importance of American banks relative to those of Japan, Europe, and other developed countries.15 Previous studies which have focussed on size or performance have assumed a duality of entry and growth, which, while generally valid, may not always hold. Factors which make entry more likely may reduce opportunities for growth or performance, or vice versa. For example, it is often suggested that one of the reasons for the widespread establishment of P R C government-controlled subsidiaries such as trading companies in the colony of Hong Kong has been the desire to have a training ground where cadres could learn free market techniques first-hand in order to deal more effectively with 9. Grant (1987, p. 81) provides a concise summary of possible reasons for this superior profitability. 10. e.g., Fieleke, 1979; Nigh et al., 1986. 11. e.g., Khoury, 1980; Goldberg and Saunders, 1980, 1981. 12. e.g., Goldberg and Saunders, 1980; Giddy, 1983. 13. e.g., Khoury, 1979; Goldberg and Saunders, 1981; Damanpour, 1986. 14. e.g., Ball and Tschoegl, 1982; Terrell, 1979. 15. See United Nations (1988, p. 114) for an analysis of recent changes in market share by banks headquartered in the leading industrial countries. Even in U.S.-oriented studies, the number of variables actually found significant is not large, as can be seen from Table 1-3. 9 Western businessmen. In this case, the motivation for the foreign investment is the lack of the skills required to make one successful and profitable. Similarly, it has been suggested that many banks "have invested in the United States primarily to gain experience in a dynamic and innovative market" (Office of Technology Assessment, 1989, p. 202). A bank may also open a branch in a major international financial centre (IPC) for the benefits it yields in terms of prestige. Here again, the motivation is a lack of the very thing that would make one successful in the host market. The point of the above discussion is not to argue that entry, growth, and performance are totally separate phenomena. In reality, of course, they are probably closely related: one must enter to grow, and a certain potential for growth and performance is usually necessary for entry, with greater potential generally associated with a greater probability of entry. However, while a few authors (e.g., Cleave, 1974) have speculated about possible reasons for entry apart from strict profit maximization, there has been almost no empirical work which compares the factors associated with entry and those associated with performance to tell us whether they are indeed similar. Of the empirical studies summarized in Table 1-3, only Ball and Tschoegl (1982) and Heinkel and Levi (1989) touch more or less directly on the question of entry. Thus, a second contribution of this study will be to examine specifically the extent to which entry and performance in the host market seem to be associated with similar factors. Examining performance alone may be misleading since some of the advantages of having an overseas location may accrue to parts of the bank outside the host location. 10 Banks can enter a market through FDI in several ways: branches, agencies, representative offices, subsidiaries, or affiliates.16 As Heinkel and Levi (1989) have pointed out, the choice among branch, subsidiary or agency forms is primarily influenced by host regulations. Thus an M N B typically has a choice of two entry modes: a branch (which we shall take to include subsidiaries and agencies where regulations so mandate) or a representative office. We know as yet very little about why some banks choose one form and others another. Most previous studies either look only at branches (e.g., Goldberg and Saunders, 1980; Cho, 1985) or lump all forms together (e.g., Choi et al., 1986). Others (e.g., Aliber, 1984) do not really deal with multinational banking at all, but rather the accumulation of foreign assets, regardless of whether they are gathered at the head office or by overseas branches. Organizational form is an interesting question because banks which seem in many ways similar often have dramatically different patterns of overseas representation. Clendenning (1976, p. 110), for example, has pointed out that each of the "Big Five" Canadian banks adopted a different entry strategy, although they are roughly similar in size and extent of domestic coverage. Although some work has been done on the more general M N C problem (e.g., Anderson and Gatignon, 1986; Grosse, 1985), such studies typically look at decisions among entry modes such as licensing, joint ventures, and wholly-owned subsidiaries, while in banking 16. Branches, agencies and representative offices are integral parts of a bank, while subsidiaries and affiliates are separately incorporated. Branches undertake both lending and depository functions, although these are sometimes limited to offshore or foreign currency transactions depending on local law. Agencies are found almost exclusively in the U.S. and are basically branches without active deposit-taking functions. Representative offices can solicit business for booking elsewhere, but cannot themselves conduct any banking business on the host country's soil. Subsidiaries and affiliates differ in the extent of foreign ownership: subsidiaries are controlled by the foreign bank, while affiliates have only a non-controlling interest owned by a foreign bank. 11 almost all FDI is by means of a wholly-owned operation (branch, agency, subsidiary or representative office).17 For an M N B , then, the question is not usually one of control (how much should we own?) but rather one of operational flexibility (what powers is it worthwhile investing to obtain?). Only a few studies deal specifically with organizational form. Terrell (1979) analyzes loans of Japanese bank branches and agencies combined and branches, agencies and subsidiaries combined, but does not disaggregate fully by form of office. Walker (1983) compares growth rates of U.S. domestic banks and (1) foreign branches and agencies combined, (2) foreign subsidiaries alone, and (3) all foreign offices in the aggregate in several geographic regions of the U.S., but his focus is on whether foreign banks are dominating U.S. banking markets, not on factors leading to growth or entry. Goldberg and Saunders (1981) estimate separate equations for asset growth of foreign bank agencies, branches and subsidiaries in the U.S. They do not, however, deal explicitly with choice of organizational form, most likely because the choice among these  three forms is, as mentioned above, primarily a matter of regulation. Ball and Tschoegl (1982) attempt to identify factors influencing transition from a representative office to a branch in Japan, or from a branch to a subsidiary in the U.S. Their paper, however, is primarily methodological, involving a comparison of logit and discriminant analysis, and lacks a strong theoretical basis. Heinkel and Levi (1989) have presented the first study to derive an explicit analytical model of organizational form (based on relative costs and benefits) and extent of market penetration by foreign banks and to test such 17. While a number of consortium banks were established in the 1970s to enter international banking markets (particularly Eurocurrency lending), almost all have since been dissolved. (See Globe and Mail. April 16, 1990, p. B14.) 12 an approach empirically. However, the paper is not strongly linked to FDI theory, and the data used are at a level of aggregation such that only country-specific influences can be tested, and not bank-specific factors. A third contribution of this study is, therefore, to provide some insight into the extent to which different forms of FDI in banking (i.e., branches and representative offices) are motivated by similar forces. This thesis also contributes to the theoretical development of the literature on multinational banking by relying on finance theory rather than ad hoc observations to motivate models of FDI by banks. 1.5 Plan of the Thesis The remainder of this study is organized as follows. Chapter Two reviews Dunning's eclectic framework and its previous application in studies of multinational banking and then provides an alternative, or perhaps more correctly, a complementary analytical approach based on financial theory. Chapter Three outlines the methodology and data used to test the theory, including the statistical procedures and the empirical specifications of the models, while Chapter Four discusses the results of the tests. The conclusions are summarized in Chapter Five, which ends with suggestions for further research. 13 Chapter Two T H E O R Y 2.0 Introduction The purpose of this chapter is to lay the theoretical groundwork for models of the behaviour of multinational banks. This will be done by integrating Dunning's eclectic framework (1977, 1979, 1988), which has found wide use in foreign direct investment studies, with other relevant literature, principally that on the existence of financial intermediaries. Dunning's framework, which is closely related to and shares a common heritage with Rugman's internalization theory (1980, 1985, 1986), is therefore briefly reviewed in Section 2.1. The remainder of the chapter reviews the sources of banks' competitive advantages and the determinants of the location of financial services and relates this analysis to the question of why banks enter foreign markets. In the next chapter (Methodology), the models developed from these discussions are refined further to deal with the specific circumstances in the markets of interest here, i.e., Japan and Korea. The results of the empirical tests are then reported in Chapter Four. 2.1 Dunning's Eclectic Framework Dunning divides the forces leading to foreign direct investment into three groups. Ownership-specific advantages (OSAs) are those (usually intangible) resources and attributes which a company has which enable it to compete against local firms that do not have to overcome costs of "foreignness." Examples are superior technology, preferential access to some resource, and better management skills. Internalization incentives are the factors which motivate a company which has an O S A to exploit it itself. Usually these relate to some form of market failure in transactions involving the 14 O S A . Finally, location-specific advantages (LSAs) are the attributes of possible locations, such as access to or the cost of immobile resources, that encourage production in one country rather than another. Dunning's theory posits that necessary and sufficient conditions for foreign direct investment require the presence of all three types of factors. First, a company must have an O S A . Second, it must have an incentive to internalize it (i.e., use it itself rather than selling or renting it). Third, the relative location-specific advantages of the home and host markets must favour production in the host. Table 2-1 summarizes the essence of the theory's implications for a firm's international involvement. For any cross-border dealings, an O S A is needed. If there is an internalization incentive for the firm to exploit this advantage itself, but no L S A favouring the target market, the firm will exploit the advantage by producing at home and exporting. If, on the other hand, there is no incentive for the firm to exploit the O S A itself, but LSAs favour production in the target market, licensing is the optimal way to use the O S A . Only when all three types of factor are present will foreign direct investment come about. Three earlier studies apply Dunning's eclectic theory to multinational banking issues. The first of these is Gray and Gray (1981), a theoretical article which, while useful in many respects, suffers from three major shortcomings. First, it attempts to deal only with location-specific advantages (LSAs) and internalization incentives, simply assuming ownership-specific advantages (OSAs) to exist. Second, it does not properly categorize these factors due to an apparent misunderstanding of the nature of LSAs, which are those advantages that provide a benefit for production in one country as opposed to the other, such as (delivered) factor costs and availability (Dunning, 1979, 15 p. 276).18 Third, it advances the notion that expansion into "supranational" markets is beyond the explanatory ability of the eclectic framework and proposes instead an "escape from regulation" hypothesis. This is clearly unnecessary, as lack of financial regulation fits easily into the eclectic framework as an LSA. Moreover, foreign banks which enter an IFC supranational market must possess OSAs, or else the supranational market would be dominated by the local banks which were already established in these offshore markets and were not handicapped by long distances from their headquarters. There must also be some incentive to internalize these transactions, or funds would simply be supplied to local banks in these locations via the interbank market. Yannopoulos (1983) was the second to apply Dunning's framework to banking. His article avoids the "dual theory" pitfall of Gray and Gray and provides a number of useful insights, but is mostly historical and descriptive. As with Gray and Gray, no empirical tests are performed. Cho (1985) was the first to use the eclectic framework in empirical work on multinational banking. Like Gray and Gray, however, he misclassifies several factors. Most of Cho's empirical tests are also run on a one-home-one-host country basis to the detriment of both the richness and generality of his conclusions. His results, along with those of other empirical studies, are summarized in Table 1-3 presented earlier. 2.2 Applying the Eclectic Framework to Multinational Banking 2.2.1 The Nature of the Industry: Identifying the Key Ownership-Specific Advantages in  Banking and the Incentives for Their Internationalization The ownership-specific advantages that enable firms to compete successfully will vary depending on the nature of the industry under study. To understand what drives 18. Thus, for example, the presence of subsidiaries of home country MNCs is incorrectly treated as an L S A rather than as a proxy for the O S A an M N B possesses by virtue of its stock of information on existing customers (see section 2.2.2.2). 16 competition in the banking industry requires an understanding of the functions which banks19 perform in intermediating between borrowers and lenders. It is by no means immediately obvious why, in a modern financial system with relatively efficient financial markets, borrowers and lenders do not contract directly with one another, thereby eliminating the need for an intermediary which must, in order to survive, pay lenders (depositors) a lower rate and/or charge borrowers a higher rate than that which might prevail under direct contracting. The answer appears to relate to intermediaries' ability to overcome market failures which inhibit direct exchanges of financial assets among wealth-holders. The level of skill and special techniques which a bank uses to overcome these market failures by internalizing transactions which could potentially be conducted in markets determine whether it has OSAs to exploit in both domestic and foreign markets. Since banks are essentially in the business of internalizing transactions, many of their OSAs will be inextricably tied to incentives to internalize them. In other cases the scope of internalization may not be as predetermined and it becomes necessary to look at specific causes for the failure of markets in the OSAs to determine why banks choose to exploit them themselves. Chan (1983) identified four fundamental roles intermediaries have been hypothesized to fulfill, including: i) reduction of transaction costs, ii) portfolio optimization and asset transformation, 19. The term financial intermediary, or bank, will in this section be taken to mean simply a firm which takes in deposits and makes loans. For discussions of why banks typically provide other services such as chequing accounts, safety deposit boxes, etc., see Fama (1980), Benston and Smith (1976), Campbell and Kracaw (1980), and Santomero (1984). The primary explanations revolve around transaction costs, regulation, and economies of joint production. 17 iii) information production and signalling, and iv) monitoring of borrowers.20 The sub-sections which follow attempt to explain the nature of each of these roles and then to explore: (a) how they may give foreign banks a competitive edge over local banks in a host market, (b) which banks are likely to have the strongest advantages in each role, (c) how each role can affect "costs of foreignness," i.e., the disadvantages foreign banks face as they compete with local banks, and (d) which banks will be least affected by these costs. 2.2.2.1 Transactions Costs and Diversification It has been claimed that "the raison d'etre for this industry is the existence of transactions costs" (Benston and Smith, 1977, p. 215).21 In this view, "financial intermediaries create financial commodities... because they have a comparative advantage in processing documents, in acquiring information about borrowers' ability to repay debts, and in monitoring instruments that can be easily converted into generalized purchasing power" (p. 222). According to Benston and Smith, this comparative advantage can arise because of: (a) economies of scale resulting from specialization, which allows the use of specialized machinery and the reuse of information about customers when 20. It is, however, difficult at times to distinguish clearly among the roles, particularly inasmuch as a number of the models were formulated primarily to highlight some specific aspect of intermediary behaviour (such as economies of scale or asset management) and touch on the question of existence only as an aside. 21. See also Benston (1972), Gurley and Shaw (1960), and Stillson (1974). 18 dealing with others with related characteristics (e.g., firms in the same industry).22 (b) a reputation for discretion which lessens the chances that borrowers' profits will be dissipated through the untimely release of strategic competitive information.23 (c) a reduction in the search costs which would be incurred by borrowers and lenders in a direct matching process. The advantages of specialization in particular market segments and of preservation of confidentiality will be discussed more fully in the subsections which follow. Thus the primary transaction costs considered here are search costs. If borrowers and lenders had to contract directly with one another, one can easily imagine the difficulties they might encounter as they searched for counterparties with exactly offsetting needs. Those with uncommon needs would be the most severely affected, as markets for them might well be either very thin or non-existent. A bank's in-depth familiarity with the financial needs of large numbers of clients simplifies the task of matching up companies with offsetting requirements and thereby reduces search costs.24 For the more common needs, a large numbers or "pooling" effect may reduce or eliminate the need for direct, one-to-one matching. Given their size, banks can also 22. The theme of information reusability, both cross-sectional and over time, is developed more fully by Chan et al. (1986). (See below.) 23. Campbell (1979) concentrates on this confidentiality aspect of intermediation. 24. A n example of such a service is the interest rate swap. While these can be and sometimes are done directly, banks frequently stand between the two parties who are trading their interest payment streams. The bank's role is twofold: in addition to reducing search costs they are usually a more creditworthy counterparty and hence eliminate the need for extensive mutual credit analysis by the two borrowers. 19 eliminate waiting costs by relying on future customer needs and responding immediately to special requests. In this role banks can be seen as clearinghouses for customer needs. A bank with a large, diverse customer base would have an advantage in this role in that it would be more likely to be able to match up customers with offsetting special requirements and thereby provide them with services which more closely meet their needs without incurring the costs or risks of asset transformation. Smaller, less diversified banks, on the other hand, would gain proportionally more from domestic growth since a given number of additional customers would provide a greater increase in the probability the bank would be able to directly offset client needs. Once a certain level of size is attained, a large numbers effect should also tend to balance out customer gains and losses and hence require less attention to one-to-one matching. Internationally, a bank will find that each foreign market entered opens up new opportunities to find customers to match the as-yet imperfectly met needs of its existing customer base but may add customers with needs that cannot be matched by its current client base.25 While the marginal gains from increases in domestic customer base are higher for a small bank than for a large and internationally diversified one, so are the additional risks and transaction costs associated with matching new types of customer 25. Of course, locating overseas is not the only way of offsetting customers' needs: there is also the interbank market. However, because the market requires a bank to share its profits with a counterparty, it may find it more profitable to take over both ends of the transaction for larger customer groups. Markets may also be very thin or simply not exist for some customer needs. A Citibank ad in Euromoney (June 1989 "Twentieth Anniversary Supplement," pp. 244-245), for example, focussed on the bank's ability to structure foreign exchange transactions in blocked and illiquid currencies as a result of having branches in locations such as Cairo. Even some very large private companies such as RJR Nabisco find it beneficial to avoid the market by performing an internal netting of common foreign exchange needs (e.g., six month Deutsche mark forwards) (Office of Technology Assessment, 1989, p. 219). 20 populations. To the extent that the population of clients in the host market is different from that in the home market (due, for example, to cross-national differences in industrial structure, risk aversion, currency preferences, etc.), a small bank may simply be adding more "unmatched" customers to its base. Similarly, host market clients stand to gain more from dealing with a bank which has a large customer base and is therefore more likely to be able to find an existing client with an offsetting need. Banks which are already somewhat geographically diversified should find that network economies arise as the opportunity to match customer needs between foreign markets grows. The increased probability of directly matching customer needs provides an explanation of the diversification motive for moving into overseas markets by foreign direct investment26 which complements the traditional explanation based on risk-reduction. Risk reduction alone can, of course, be accomplished by portfolio diversification by investors (see, e.g., Levy and Sarnat, 1979). Banks pursuing their advantages in this area would therefore be expected to enter the widest possible range of markets. Citibank appears to be the most successful follower of this strategy, as many of the others to whom it once appeared attractive have since been forced to rationalize their overseas networks. Search costs may also work against foreign banks in some cases. A n important element of the overall expected search costs a bank customer must incur is the probability that the company will have to switch banks and search for another supplier. Foreign banks probably suffer an overall disadvantage relative to local institutions in this regard because they are likely to be perceived as having less commitment to the market. Thus, depositors may fear a foreign bank will withdraw without fully paying up, while 26. Emphasized by writers such as Khoury (1980) and Rugman and Kamath (1987). 21 good borrowers fear being stranded without a reliable source of finance if it pulls out, and bad borrowers flock to it thinking it will find it easier to leave than to pursue them if the economy experiences a downturn. Finance is a key input, and customers must believe that their supplier will not withdraw it if the company experiences difficulty, that responses to credit requests related to specific opportunities will be speedily adjudicated and so on.2 7 Interruptions or delays in supply can be catastrophic, causing dumping of stock, supplier reluctance to ship and buyer doubts about guarantees. Yet information on which to base beliefs is very scarce and difficult to verify, because suppliers have an incentive to overstate their reliability, and crises where a relationship can be put to the test are infrequent. With one group, however, a foreign bank has an advantage in this area. A bank's existing home-country clients have a stock of information based on past dealings which erects switching barriers to dealing with another bank when they move overseas. This advantage should be greatest among a bank's small and medium-sized clients, as they are likely to have the strongest fears of being deserted by an unfamiliar bank and the greatest difficulty adapting to foreign business practices (Euromoney "Supplement on Japanese Banks in the U.S.," July 1988, p. 16). Barriers which deter customers from switching banks are also likely to be particularly strong when subsidiaries are first established and local banks are totally unknown. Once the subsidiary has been able to familiarize itself with local banks over 27. As the Economist put it, "Relationships are back in fashion because, if hard times are ahead, even the biggest clients want to be sure of their credit lines" (Survey of International Banking, March 26, 1988, p. 76). Depositors will be pleased that the foreign bank will be subject to local law in the event of any dispute. This fact will also be important to beneficiaries of guarantees or letters of credit relating to projects undertaken by the foreign bank's clients, since disputes are relatively frequent in such work (see Business Week. February 22, 1982, p. 106 for some of the hazards involved). 22 a period of time, dealing with the home country bank may be less important.28 This may account for the observation that MNBs often precede MNCs (Walter, 1985), as this would enable the MNBs to exploit their advantage in serving new arrivals. If so, FDI by home country industrial firms should affect entry and the early growth and performance of an overseas branch, but have little effect on long-run results. Even apart from such customer-related advantages, however, not all foreign banks will suffer the same commitment-related costs of foreignness. Since large banks can bear more short-term losses before having to pull out, such costs should be less for them, and they should require less of an O S A than their smaller competitors before finding it profitable to move overseas.29 In summary, then, banks' role as transactions cost reducers should tend to give large banks the greatest incentive to move overseas, and this advantage should become stronger the more overseas countries they are already operating in. 2.2.2.2 Asset Transformation30 Search costs alone may not be a sufficient explanation for the existence of banks since one could imagine brokers matching borrowers and lenders for a fee without actually taking in deposits and making loans. A supplementary explanation emphasized by one group of writers31 links banks' competitiveness to their capacity to "modify the attributes of financial claims (such as their duration, numeraire, divisibility, etc.)" and 28. See Tschoegl (1987, p. 78) for a related discussion in a retail banking context. 29. For any given size, higher capitalization should tend to have the same effect. 30. The term "asset transformation" includes technology on both sides of a bank's balance sheet, as the assets it "transforms" are those of its depositors, and hence are its liabilities. 31. e.g., Klein, 1971; Pyle, 1971, 1972; Deshmukh et al., 1983a, 1983b; Diamond and Dybvig, 1983. 23 thereby become "asset-transformers" (Deshmukh et al., 1983a, p. 142). For example, Diamond and Dybvig (1983) focus on banks' ability to transform illiquid assets (e.g., loans) into demand deposits.32 If transactions cost advantages tend to push banks towards becoming large and diversified, asset transformation advantages may tend to work in the opposite direction. Every bank must choose to provide some finite subset of the infinite range of financial services possible. Customers' needs are therefore unlikely to be met exactly and they must bear higher than necessary costs as they attempt to "make do" with suboptimal bundles of services. Banks which are better able to tailor their services to match the exact needs of customer groups will be able to increase their profits by some fraction of the customers' savings. Such tailoring, however, requires a sharp focus on one or a few groups' needs. For example, a bank may specialize in the financing needs of real estate developers, and concentrate its funding efforts on groups looking for outlets for investments with matching characteristics. In this way, it acquires special asset transformation skills which produce services which meet the needs of these two groups more closely than those of mainstream banks. In contrast to the transaction cost reducer, which meets customer needs by bringing in more and more customer groups to increase the probability of offsetting needs, the asset transformation specialist meets its customers' needs by building a stronger and stronger bridge between them. Even banks 32. In their model "illiquidity of assets provides the rationale both for the existence of banks and for their vulnerability to runs" (p. 403). Even though one of the possible equilibria of their model is undesirable in that all depositors panic and attempt to withdraw their funds, and hence intermediaries must be very concerned about public confidence, a bank issuing demand deposits can raise welfare by improving risk sharing among people with different patterns of stochastic consumption needs through the provision of greater liquidity. 24 which concentrate on asset transformation will benefit from size, however. For example, the pooling of large numbers of small, short-term deposits may make the total amount of deposits sufficiently stable to reduce the risks of making large long-term loans. Once a bank has developed such special skills, foreign markets provide the opportunity to find new groups in need of them and to spread the investment in their acquisition over a broader base. While this investment seldom involves a great deal of physical capital (equipment, etc.), it often includes a large component of sunk costs in terms of highly skilled labour spent perfecting ways of making the product acceptable to both the marketplace and the institution. Being able to exploit the innovation as widely as possible is particularly important since it is seldom long before it is copied by other institutions if it proves successful. Multinationalization may also allow a bank to achieve a "critical mass" in several areas of expertise for which the domestic demand is insufficient for long-run growth and stability of income. This critical mass may, in addition to spreading costs, provide sufficient stability in the total demand faced by the bank to reduce the risks associated with asset transformation (see above). Banks which have the strongest asset transformation skills are likely to have high market shares in high value-added financial services relative to their size.33 Overseas their special skills in serving users of these products enable them to overcome the disadvantages they are likely to face in the market for general banking services due to their lack of familiarity with local conditions. 33. Ignoring size could be misleading since a bank could have a "high" market share just because of its size, even if it were not particularly adept at serving that customer segment and had a lower market share in it than overall. 25 2.2.2.3 Information Production and Signalling The simplest way in which banks "transform" assets is by taking in deposits from one group (savers) and making loans with different characteristics to another group (borrowers). For this process to work, banks must be able to differentiate good borrowers from bad, and savers must be able to differentiate good banks (ones which will repay deposits) from bad ones (which won't). To a large extent, banks must rely on information from borrowers in their credit granting decisions and savers must rely on information from banks about their soundness. Unfortunately, "moral hazard hampers the direct transfer of information between market participants... since there may be substantial rewards for exaggerating positive qualities" (Leland and Pyle, 1977, p. 371). Thus an important determinant of a bank's competitiveness will be its skills in overcoming these information asymmetries by acting as information producers or signalling agents which produce information to enable them to tell the good borrowers from the bad, and then signal to potential providers of funds (depositors) that they have this good information (Leland and Pyle, 1977; Draper and Hoag, 1978; Campbell and Kracaw, 1980; Chan, 1983). In principle information asymmetries could be resolved by information production organizations which produced and then sold information. Leland and Pyle (1977), however, argue that in at least some cases "pure" information sellers face two daunting obstacles: the "public good" nature of information, which may prevent them from appropriating its full value, and a credibility problem similar to that of entrepreneurs if it is hard to tell good information from bad, ex ante. This leads them to conclude that advantages of this type must be internalized since "both these problems in capturing a return to information can be overcome if the firm becomes an intermediary, buying and 26 holding assets on the basis of specialized information" (p. 383). The "public good" problem is resolved because the value of its information becomes impounded in the return on its portfolio, while the credibility problem can be overcome through signalling based on the organizers' investment in the firm's equity.34 Their model predicts the high degree of leverage typically found in intermediaries' balance sheets as a result of the low level of specific risk they face, but its prediction of a high degree of bank ownership by management seems at odds with today's practice. It may be, however, that alternatives to ownership have arisen to signal management commitment to information as capital needs have grown beyond the resources of individuals. In particular, the implications of their model in this respect are consistent with the observed practice in banking of considerably longer tenure than in other industries being required before receiving decision-making authority, and of many banks being wary of hiring those trained in another institution. In essence, a large investment in firm-specific human capital is required from information producers within the firm before their views are given credibility.35 "Sorting" of the type described above is not the only way in which information production skills can enhance a bank's competitiveness. Sorting of the type discussed 34. Leland and Pyle's model leads to the conclusion that entrepreneurs can signal the quality of their projects by their willingness to invest their own money in them: "the market reads higher entrepreneurial ownership as a signal of a more favourable project. And the entrepreneur is motivated to choose a higher fraction of ownership in more favourable projects..." (p. 376). In a similar way, information producers who are confident in their judgments should want to take a larger stake in their loans than those with less confidence. 35. Draper and Hoag (1978) devote considerable attention to the internal credibility problem, which they resolve through a dichotomous compensation contract with "large penalties for outcomes which would be very unlikely when the optimal effort is supplied" if individuals' effort level is unobservable (p. 609). 27 in Campbell and Kracaw (1980) implies that the characteristics of firms are exogenous. If, however, their characteristics can be at least partially determined by entrepreneurs and their behaviour is affected by the degree of scrutiny they receive, a bank with strong information production skills can induce borrowers to undertake superior projects (Chan, 1983). This, in turn, can provide the bank with higher returns and/or lower risks on its loans. Chan also points out that to the extent that information about firms is reusable (e.g., because of commonalities within industries), intermediaries can also conserve on information costs even when they are the same for intermediaries as for individuals.36 Information can be reusable cross-sectionally if borrowers are similar, as one would expect if a bank were implementing a focussed asset transformation strategy. Such a bank is likely to develop information production advantages in its area of specialization. If it concentrates on financing real estate development, for example, learning about developers' needs will lead to greater insight into how to distinguish the good ventures from the bad, and the shady entrepreneurs from the forthright. These OSAs will raise its profitability by lowering its losses from investment in ill-fated projects. In general, the difficulties banks face in evaluating borrowers because of lack of familiarity with the local cultural, political and legal environment could be considered the main "cost of foreignness" handicap they face in overseas markets.37 Experience, 36. The term reusability is used quite broadly in this context in that it is taken to include both the durability of information (i.e., the degree to which its time rate of decay is low) and the probability that the bank will be around to use it again (i.e., remain solvent). In later work Chan et al. (1986) develop this concept further, showing that when information is reusable banks do more costly screening and hence select better assets. 37. They can, however, overcome this handicap by concentrating on sectors in which they have an information processing advantage, such as a specialized industry, or retail or business customers from their own country. (See below.) 28 however, can be an equalizer since, as Tschoegl (1987) has pointed out, "after several years in a country, the foreign bank's knowledge of the local environment will equal that of any other firm" (p. 73).38 The rate at which the burden of costs of foreignness will decline depends on the shape of the learning curve, which in turn depends on the extent of a bank's international experience, the activities in which the bank is engaged, and the degree of transparency of host country regulations. Banks with extensive international experience should be able to overcome costs of foreignness more quickly that those with less experience. First National City Bank (now Citibank), for example, is said to have opened branches in many countries because "the depth and experience of the international staff enabled the bank to make money in countries where its competitors could not" (Cleveland and Huertas, 1985, p. 263).39 38. Even where the costs of being foreign are primarily nuisance costs of discriminatory host government treatment (Walter, 1985, pp. 72-75), with time a bank should be able either to lobby for change or to develop coping strategies. 39. Banks with extensive international expertise should also be better able to evaluate the profit potential in foreign markets than less experienced competitors. It is unclear, though, whether this will lead them to enter markets earlier. Gilbert and Lieberman (1987) have shown, for example, that a "bandwagon effect," whereby some firms imitate the investments of others, can be rational behaviour generating an equilibrium outcome when the imitators know that the initial investors are better informed about market prospects and that their act of investment therefore conveys information about the likely future state of the world. Inexperienced banks, presumably, are aware of the information advantage of their larger competitors, and seek to infer what information the latter have by observing their actions. To the extent that they perceive themselves to have similar OSAs (perhaps because these are nationality-based - see, e.g., Dohner and Terell, 1988), such banks may rely on the judgment of the larger banks for an assessment of the relative LSAs of the home and host markets and the matching of OSAs to overseas market needs. It would then be rational for them to follow the lead of the larger, more international banks in their overseas branching activities. Nesper (1984) found evidence in his study of the overseas branching patterns of U.S. banks that "the lead in office dispersal was taken by the very largest banks... while a smaller asset size calls for greater caution and increases the proclivity to join the pack at office agglomerations [financial centres] for mutual support and greater certainty" (pp. 109-110). 29 Banks which target the market for trading-based (as opposed to lending-based) activities should also be able to fit in quite quickly since the number of market participants is quite small, most are relatively sophisticated, such as other foreign and local banks,40 M N C subsidiaries, large local corporations, etc. and many may even be familiar from dealings elsewhere. The newcomer therefore need only learn the local regulations and invest a small amount in initiating relationships with others in the market. Lending-oriented banks, on the other hand, are likely to have a much longer period of learning because these relationships are of a longer-term nature and therefore require better long-term forecasting abilities. In addition, as one seeks to expand market share sooner or later one must almost inevitably move to smaller companies, whose finances and management are more difficult to evaluate than those of major corporations, which often make at least some effort to make their standing apparent to foreigners. Wright (1987, pp. 15-16), for example, highlights the perils foreign banks face in penetrating the "second tier" of companies in Japan. Such firms will likely also be more suspicious of dealing with a potentially "footloose" foreign bank due to their greater difficulty in finding alternate banking arrangements if a bank withdraws its support at an inopportune time.41 Finally, where regulations are clear, public, and unambiguous, a bank can learn them quickly, but where published regulations simply establish the framework within which regulatory officials exercise their discretion, the process of learning the ropes may be much longer, slower, and more costly. 40. In 1989, for example, it was estimated that over 80% of banks' foreign exchange turnover was with other banks (Federal Reserve Bank of New York, 1989, Appendix 1(a)) and only 10% related to trade (Globe and Mail. September 22, 1989, p. B l ) . 41. While Giddy (1983) disaggregates international banking activities more finely, these conclusions are consistent with his view that barriers to entry are higher in lending than in trading activities (p. 210). 30 There is, of course, one customer group in the analysis of which any bank enjoys an information production advantage: its existing home country customer base. Banks develop a large stock of knowledge of their customers at all levels of the organization. This stock includes not just financial data (which may be an advantage in any case, if the client company is privately owned and wishes to maximize confidentiality), but also personal evaluations of management's credibility and idiosyncrasies (optimism, foresight, etc.), knowledge of warning signals (what to fear and what is normal), familiarity with preferred business practices, etc. The advantage inherent in possessing this information is the foundation of the "follow-your-customer" explanation of bank FDI, which is among the most prevalent in the literature.42 The "follow-your-customer" hypothesis has aggressive and defensive variants, which are both expressed clearly in this quote from Vernon: The propensity of banks to follow their customers abroad was due partly to the fact that they had an inside track in securing the business of the foreign subsidiaries of such customers, and partly to a fear of the consequences if they failed to follow their customers abroad. As the banks' strategists saw it, if they failed to corral the subsidiary's business abroad, rival banks would have an entry wedge into the multinational network of their customers, and that entry could lead eventually to a rivalry for the business of other members of the same network, including the business of the parent, itself (from commentary on Dean and Grubel, 1979, p. 434). The "follow-your-customer" motivation was probably quite important in the earlier days of multinational banking, when only a few countries' banks could supply state-of-the-art services and MNCs therefore had strong supporting reasons for maintaining relationships with their home bankers. Today, however, these capabilities are widespread, at least among banks from the developed countries (Economist "Survey of International 42. e.g., Grubel, 1977, pp. 352-3; Vastrup, 1983, p. 120; Tschoegl, 1981, p. 207; Yannopoulos, 1983, p. 245. 31 Banking," March 25, 1988, p. 60). Moreover, banks are multi-product firms, and few overseas branches can economically provide a full range of services, so using a local bank is almost inevitable for most M N C subsidiaries sooner or later. In most cases, then, it is quite difficult to imagine that most banks could keep their customers from dealing with other banks by following them abroad. Such customers may, however, provide a relatively easily obtainable base of business in a branch's early years. The transition from an early home-country-subsidiary orientation to a later local market emphasis is illustrated by the following quote from the trade press: Most Japanese banks set up offices in the United States initially to serve domestic clients expanding abroad. Today, the Japanese customer base in the U.S. often represents only a sniall proportion of total business. The emphasis has shifted decisively in favour of American borrowers (Euromoney "Supplement on Japanese Banks in the U.S.," July 1986, p. 15). Today, then, the "follow-your-customer" effect is probably important only for new banks or new subsidiaries in a host market, in some L D C or NIC hosts (where the technological gap reinforces the bank's advantage in client knowledge), and for MNBs from home countries (such as Japan or Korea) whose MNCs suffer from strong language/cultural/business practices differences when dealing overseas. Khoury (1980, p. 148), for example, found a strong relationship between Japanese non-bank FDI in the U.S. and growth in commercial and industrial loans by Japanese banking institutions in the U.S. 4 3 In such cases, the ability to rely on security in the home country through comfort letters may be a reinforcing factor (Yannopoulos, 1983, p. 255). Four recent studies have nonetheless reported strong confirmation of the "follow-43. See Landa (1981) on the role of shared culture in reducing transactions costs and Tschoegl (1987, p. 78) for a related discussion of retail banking. 32 your-customer" hypothesis. One of the most recent of these (Sabi, 1988) looks at U.S. MNBs in the LDCs, and is entirely compatible with the arguments made here. Nigh et al. (1986) found U.S. M N B assets to be independent of local market activity but strongly affected by FDI by U.S. MNCs in 30 countries and various subsets of same (e.g., developed, L D C , Asian, etc.). Their study, however, suffers from severe methodological flaws which strongly bias the analysis in favour of finding an FDI effect at the expense of a local market effect (notably by regressing changes in U.S. bank branch assets on changes in U.S. FDI, but on the level of local GNP). Jain (1986) interprets his findings as strongly supporting the "follow-your-customer" explanation of FDI by U.S. banks, but his regressions analyze overall loan portfolios (whether lent from home, host or third countries) and thus actually shed no light on the issue. Hultman and McGee (1989) find support for a link between FDI and the growth of foreign bank branches in the U.S. However, given the rapid growth of FDI in the U.S., there are undoubtedly many new subsidiaries which may not yet be sufficiently acclimatized to the U.S. environment to rely solely on U.S. banks. In short, none of this evidence contradicts the somewhat more limited version of the follow-your-customer idea presented here. A bank's existing client base also provides a captive volume of international payments via wire transfers, clean and documentary collections, letters of credit, etc. (Lees, 1974, p. 61). In the absence of an overseas branch, these transactions would be directed to correspondents,44 usually in exchange for a reciprocal flow of transactions. Once a branch is established, however, they can be handled within the organization, 44. A correspondent is a bank in a foreign country with which a bank maintains a business relationship to enable it to conduct routine transactions overseas, particularly in countries where it is not directly represented. A correspondent might, for example, maintain a bank's account in the host country so it could make payments on its behalf. 33 thereby raising the profits (and employment) of the branch on an ongoing basis. On strictly economic grounds, it may seem unlikely that the possibility of recapturing such business would strongly affect entry since there is little incentive to internalize the transactions, given that diverting them to one's own branch will likely result in the loss of the reciprocal business flow. Following this reasoning, strong incentives to internalize would exist only where the correspondent's service was poor or where the underlying trade and investment flows did not provide a reciprocal source of profits. Even in the latter case there would have to be some reason inhibiting a balancing cash payment, such as the correspondent's lack of an accounting system adequate to quantify the imbalance. A broader view, however, recognizes that if there is not a major cost difference it may be preferable to transfer these services to an overseas branch because the presence of a large operation which would require stiff redundancy payments to close enhances clients' perceptions of the bank's commitment to the market. These "reputation" or "image" effects may provide the missing incentive to internalize. A bank's need to maintain the ability to signal that it has a good portfolio of assets can act as a constraint on the pursuit of either the "search costs reducer" or the "specialist" strategies. If a bank is perceived as having gone too far and having "all its eggs in one basket," its ability to convince depositors and other creditors of its safety is likely to be impaired. Diversification which exceeds the bank's range of information processing expertise will also result in a loss of confidence. But in addition to steering banks towards a middle course, the signalling role can also be an independent area of competitive advantage. 34 Campbell and Kracaw (1980) also take up the problem of how to signal reliability to the market.45 They conclude that "investors will only invest in firms which have large enough endowments to verify their reliability" (p. 879), or, as they more pithily put it in their 1983 paper, "People are only as reliable as what they have to lose" (p. 1097). In their model: "Highly efficient information producers with small portfolios will be unable to compete with less efficient producers who have sufficient wealth to establish their reliability. As a result, it is likely that information will be produced less efficiently than it otherwise might and the opportunities for collusion among information producers will be enhanced" (p. 879). In contrast with Leland and Pyle (1977), they maintain that it is not intermediation itself which resolves the moral hazard problem, but rather the information producer having a large enough stake in the market to achieve credibility. Another method of signalling asset quality to the market is suggested by Cornett (1988). Since it may be socially optimal not to catch all lawbreakers (Stigler, 1970), individuals face the risk of loss of assets through theft. Cornett constructs a model in which individuals must allocate their wealth among non-stealable goods, stealable goods (with or without insurance), and risk-free demand deposits in a bank. She then demonstrates that "as long as there are individuals who are sufficiently risk averse, a demand for depository institutions exists. The risk of a loss of return involved with the holding of stealable goods and the increased variability in returns renders the deposit of cash the preferred alternative" (p. 727) for such individuals. Moreover, "provided that individuals have varying degrees of risk aversion a demand for both depository institutions and insurers exists" (p. 729). The security measures a bank takes to protect 45. See also further comments in Chan (1983) and Campbell and Kracaw (1983). 35 its assets may also provide a signal as to their quality, since a bank with a good portfolio of assets will naturally want to take good care of them.46 Banks which have developed a special ability to convey an air of solidity and safety through strong capitalization, the long tenure of capable staff members, the design of their premises, their advertising, or other means, will, ceteris paribus, be more likely to be entrusted with the wealth of depositors, and hence have more assets to match or transform. These advantages, which might be referred to as "liability side technology," are likely to be of particular benefit in times of financial instability. Once banks move abroad, there are even more ways in which they may be perceived as having "security" or "reliability" advantages than in the domestic market. Some banks (e.g., the Swiss) may have such advantages simply by virtue of their nationality, while others, particularly those from countries with sophisticated financial sectors, may have advantages in less-sophisticated markets because depositors are aware that they have been able to survive more advanced competition and the more demanding scrutiny of better-trained regulators. Participation in a number of sophisticated markets means, in effect, multiple endorsement of the bank's standing. Foreign banks may also be perceived as being beyond the influence of the local government, an advantage which is particularly strong where the government has had a bent for meddling in financial affairs to the detriment of depositors. Baum (1974), for example, attributes the success of Canadian banks in the Caribbean even in the presence of state-owned or state-sponsored banks to their superior reputation, and in particular to their ability, in a 46. This may be one reason why bank vaults tend to be so prominently displayed in branch locations and why in earlier days bank branches tended towards rather pompous classical stone architecture. 36 situation where "people do not trust their government... to induce people to take their money out from under the 'mattress' and place it on deposit... Being able to write a cheque on a bank that has billions of dollars in assets becomes a mark of a person's worth" (pp. 15-16). Security and reliability advantages in this area will spill over into services other than borrowing and lending as well. In the area of performance and other contract-related guarantees, for example, a foreign bank which can deal at arm's length with the beneficiary (often the local government) may be preferred over local institutions. The information production and signalling roles, in summary, should provide banks with an incentive to enter markets where there are large groups of familiar borrowers (e.g., compatriots or home country clients) and make the entry of heavily capitalized banks more likely. 2.2.2.4 Monitoring Even if a bank has good information production skills and is able to differentiate between ex ante "good" and "bad" borrowers, it is still subject to the risk that due to changes in the environment or in the utility to the borrower of "cheating" the value of its investment may decline. Thus, another important source of competitive advantage for a bank is its ability to monitor borrowers after funds have been advanced to ensure that a change in external conditions or a lack of due diligence by borrowers does not impair the value of its loans (see, e.g., Diamond, 1984). Hoshi, Kashyap and Scharfstein (1989a, b) have presented evidence from the investment behaviour of Japanese corporations that is consistent with the importance of banks' role as monitors.47 47. If borrowers could not "shop around" for loans, the threat of a cut-off of future credit would be sufficient to ensure borrowers always acted properly (Haubrich, 1989). Monitoring would then be extremely simple since only outcomes (and not the underlying 37 The most direct benefit of good monitoring skills to a bank is the reduction in bad loan losses which it incurs relative to its less skilled competitors. These lower costs can then be used to lower loan rates or raise deposit rates to increase market share, or can contribute directly to higher profitability. Another channel through which monitoring abilities can contribute to a bank's competitive advantages is suggested by Berlin (1987) who seeks to explain why we see borrowing done both through direct contracting in securities markets and through financial institutions-even by the same firm. 4 8 Berlin maintains that what sets banks apart from intermediaries such as mutual funds (which also overcome many transactions costs and transform assets) is that other intermediaries "do not supervise firm managers and enforce loan contracts. Thus, a single transaction cost, the cost of monitoring firms, is key to understanding the difference between bank lending and other types of intermediation" (p. 11). The alternative to such monitoring is bond covenants but since these are inflexible, they will appeal mainly to "large firms with long histories in established markets" since "it is relatively easy to design covenants that will not prove overly burdensome when sales revenues are stable and when the firm's usual balance sheet ratios are well known" (p. 14). Bank loans are more flexible because the bank can monitor the borrower more intensively and investigate poor results more thoroughly, thereby reducing the risk of incurring unnecessary bankruptcy costs through the premature breakup of a firm undergoing severe but temporary financial processes) would need to be monitored. This conclusion, however, depends critically on the assumption that borrowers do not have alternative sources of credit which they can tap if their bank withdraws its support. In practice, of course, they frequently do because noise in the environment can make it hard to determine the true reason for the borrower severing its previous banking relationship. Thus, monitoring is unlikely to take the simple form alluded to by Haubrich. 48. See also Berlin and Loeys (1988) for a formal model in which firms choose between financing arrangements which can be interpreted as "bonds" and "banks." 38 problems. Even large, stable firms, however, frequently borrow at least some money from banks. Berlin explains this by pointing to the public good nature of monitoring: "While it is true that a bank must have a substantial stake in a firm... it doesn't follow that it must maintain all of the firm's debt. As long as the bank is closely monitoring the firm, the firm's other investors also benefit, even if they remain passive" (p. 14). In short, "when a firm takes out a bank loan, in effect, it hires the bank to certify that the firm is behaving efficiently" (p. 15). Berlin's argument is supported by Cable's (1985) study of West German bank-industry ties, in which the author concludes that "it is bank control as well as bank lending which raises profitability" (p. 130). Banks which specialize in asset transformation or information production to serve some specific group of customers should develop special abilities to monitor these groups after granting credits. To continue with the example used earlier, a bank which specializes in real estate development financing will not only develop the information processing abilities noted earlier which enable it to identify good projects and entrepreneurs ex ante, it will also find new ways of monitoring projects and entrepreneurs to ensure that appropriate action is taken promptly to deal with unforseen difficulties, and that entrepreneurs continue to exhibit due diligence and probity. These abilities will give such banks a competitive advantage because they will suffer lower credit losses than their less skilled competitors. Foreign banks, particularly those from distant home countries, are likely to suffer heavy "costs of foreignness" in the monitoring area if they attempt to lend only from headquarters. These disadvantages may be reduced by establishing branches in host markets to maintain ongoing contact with borrowers. Thus the monitoring role gives 39 banks an incentive to internationalize with their clients. Not only would they have an advantage over host country banks in monitoring parent operations, which may have a substantial impact on the local subsidiaries, but a network of officers on the spot would also be necessary to maintain the high degree of familiarity needed to continue close monitoring of the firms' overall financial health once they have expanded into many countries. Moreover, if, following Berlin (1987), the reason companies deal with banks even when they have direct access to credit markets is that the bank's endorsement and monitoring improves their access to direct forms of financing, dealing with a foreign bank may improve host country clients' access to financing both among domestic investors, who value an independent outsider's judgment, and among foreigners, particularly those of the bank's nationality, who value the opinion of a trusted business partner such as a major foreign bank. This endorsement should be of greater value when a bank is heavily capitalized since, as discussed above under information production, the market should have greater faith in the "certification" of a bank when it is prepared to back its judgment with more of its own (as opposed to its depositors') funds.49 2.2.2.5 Ownership-Specific Advantages and the Technology of Banking The skills with which a bank competes in the roles discussed above comprise its technology. Although technology and innovation often figure prominently in discussions 49. Government ownership, with its implicit guarantee of deposits (beyond those formally insured), may be considered a substitute for capitalization for many purposes, but may not be as helpful as capitalization in terms of signalling or "certification" value. This is because managers of nationalized banks may not have the same incentives for conservatism as those of privately owned banks, since the former know their banks are unlikely to be allowed to fail no matter what they do. As a result, their willingness to lend to a company may not convey much information to the market. 40 of FDI in the manufacturing sector,50 academic discussions of multinational banking typically give technology short shrift, since it is asserted that banking hardware is available to all,5 1 and that any product "innovations in the design of credit instruments and in the introduction of new services can be quickly emulated by other banks, domestic or foreign" (Gray and Gray, 1981, p. 40). It is certainly true that product innovations in banking do not normally enjoy the benefits of patent protection and the other mechanisms devised for the protection of intellectual property in the manufacturing sector. However, there are several reasons for concluding that technology has probably received insufficient attention as a factor providing multinational banks (MNBs) with an ownership-specific advantage (OSA). First, even though innovations are relatively easily copied in banking, they can be a short-term source of large profits to both customers and banks until the "technological gap" is closed (Office of Technology Assessment, 1989, p. 221). As a result, a record for consistent innovation will tend to attract customers who want to be first in line to benefit from future new products. The attraction should be especially strong for aggressive, growth-oriented companies, which are likely to have large and growing borrowing requirements, and for those with large pools of capital to invest. Both groups should be particularly attractive clients. The tendency for a reputation for innovation to be formed is an additional incentive to internalize any innovation, since licensing would tend to dilute the identification of the product with the innovator. 50. e.g., Dunning and Cantwell, 1987; Vernon, 1966, 1979. 51. e.g., Grubel, 1977, p. 351; Tschoegl, 1987, p. 79. 41 It must also be recognized that most technology in banking is embodied not in hardware, but in people (Walter, 1985, p. 18, pp. 38-39).52 Banks develop large and diverse teams of specialists, each of whom has knowledge of some portion of the overall process required to provide a particular service to clients. The knowledge possessed by these individuals and the patterns of interaction which have evolved among them comprise the technology required for customizing, delivering, and monitoring services (Office of Technology Assessment, 1989, p. 232). Since each person has only a piece of the picture, labour market imperfections restricting the mobility of an entire team provide some protection of such proprietary technology. They also constitute a major barrier to licensing it to others, and provide a further incentive for it to be internalized, since it is much easier to transfer one or two employees abroad within the company than it is for a whole team to be lured away by or "traded" to another bank. Banks which move into international operations may reinforce any personnel advantage they have in several ways. First, they can reap economies of scale over a certain range by ensuring full utilization of their central pool of skilled personnel, even without transferring individuals abroad (Dean and Grubel, 1979). For example, banks must develop a pool of expertise in credit adjudication to deal with their domestic operations. From time to time, cyclical downturns will reduce the domestic demand for credit and hence the workload of such staff members. However, since markets are imperfectly correlated, foreign lending can provide access to a steadier stream of credit proposals to adjudicate. This is highly desirable since it would be impractical to lay off such workers when large training costs would have to be incurred to train replacements 52. Such techniques are often referred to as "soft" technologies. See, for example, United Nations (1988). 42 when the domestic economy picked up. Given that a large part of their skills is the internalization of organizational norms of risk tolerance and knowledge of the reliability and idiosyncrasies of others in the organization, replacement of such workers would be doubly difficult. Second, the possibility of transferring members of one's own home country staff may be important despite the small number of expatriates employed at most M N B branches because it provides the flexibility of matching ever-changing opportunities with skills which have elsewhere become obsolete, are in cyclically low demand, or simply are producing a lower return than that available in the host market (Walter, 1985, p. 33). A n MNB's overseas offices provide both the information network necessary to locate such opportunities and the long-term career stability necessary to induce skilled individuals to accept temporary relocation to an unfamiliar land. The importance of this phenomenon can be seen in the frequency with which one encounters expatriates in such highly technical areas as foreign exchange trading, particularly outside of the key international financial centres, where a local pool of suitable skills has accumulated. Third, the possibility of working in overseas locations (particularly major IFCs) and the greater number of exciting management positions a multinational bank has to offer will tend to attract and retain a higher class of personnel (Cleave, 1974). It will also provide them with superior training opportunities. Finally, in overseas markets MNBs may offer better pay, working conditions, prestige and promotion opportunities (Walter, 1985, p. 41), particularly where local banks are stifled by government ownership, or where some groups (e.g., women) suffer from systemic discrimination (Tschoegl, 1987, p. 80). Working for such a bank may also be seen as a possible step towards emigration in impoverished or oppressive host 43 countries. The extent to which local staff will prefer to work for a foreign institution will, of course, vary from country to country. In Japan, for example, it is generally acknowledged that "not only do foreign companies have to pay through the nose for staff, but they must make do with fare that has already been thoroughly picked over by Japan's life-time employers" (Euromoney, May 1989, p. 22). In the days of the colonial banks, technological advantages over primitive indigenous financing mechanisms were no doubt quite broad, but today "niche" technological advantages are probably all that remain, apart from some L D C s and certain other highly regulated markets. Such advantages may arise because of the industrial structure or regulatory history of a bank's home country (Dunning, 1979, p. 282). For example, European banks, such as those in Switzerland and West Germany, have long been allowed universal banking privileges at home. They have therefore developed a considerable advantage over local banks in host countries (such as Canada, the U.S. and Japan) that are now moving, at varying speeds, towards breaking down the "four pillars" (i.e., the separation of the financial industry into commercial banking, trust banking, insurance, and securities). Some indication of the importance of technology in multinational banking can be seen in the frequency with which foreign banks have introduced innovations in host markets. In Thailand, for instance, foreign banks were leaders in the introduction of term and project financing and commercial paper (United Nations, 1981, quoted in Pigott, 1984). Even in countries with highly developed banking sectors and large MNBs of their own, foreign banks have carved out niches based on their technology. Chase Manhattan's Money Boutiques, for example, popularized consumer lending in the U.K. in the 1960s, although eventually local banks caught up. More recently, Citibank became 44 the largest foreign bank in Canada by taking advantage of its expertise in real estate financing.53 This expertise is reflected in innovative products such as profit participation mortgages (Globe and Mail. January 28, 1989, pp. B l , B4). Regulators have also frequently looked to foreign banks with the explicit goal of obtaining access to their superior technology. Taiwan has been cited as a case in point (Pigott, 1984, p. 282). The types of competitive advantage which a bank can achieve in these different areas of technology are complementary rather than mutually exclusive. For example, the value of a bank's "certification" that its monitoring has revealed the borrower to be acting properly will depend on its signalling ability, for if the bank is unable to convince the market it has good assets, its certification will be of little value. The quality of its assets will in turn depend on its information production ability (which reflects its ability to select potentially good assets), its monitoring ability (which reflects its ability to ensure they stay good), its safeguarding ability (which reflects its ability to fund them at a competitive cost), and its level of diversification and asset transformation ability (which reflect its ability to provide value to its clients at a competitive cost, and hence to stay in business). Thus, banks must develop some viable combination of these advantages, rather than developing one or another in isolation. 2.2.3 Location Specific Advantages 2.2.3.0 Introduction The ownership-specific advantages discussed above determine whether a bank will be able to overcome costs of foreignness and compete against local banks in the provision of financial services. They do not, however, tell us whether the bank will do 53. Citibank has since been displaced by two other foreign banks which took over troubled Canadian banks. 45 so from its home country or from a branch or other office in the host country. The determinants of this choice are location-specific advantages (LSAs). Five main LSAs have been suggested in the literature on multinational banking: (a) market size and growth, (b) the cost of immobile inputs, (c) regulation, (d) communications costs, and (e) signalling effects.54 Each of these LSAs is the topic of a subsection below. 2.2.3.1 Large and Growing Markets Intuitively one would expect new market entrants, whether domestic or foreign, to be attracted to large and/or rapidly growing markets rather than small, stagnant or declining markets. This intuition has been reflected in the banking literature (e.g., Terrell, 1979; Goldberg and Saunders, 1980, 1981), including that based on the eclectic framework. Gray and Gray (1981), for example, refer to market growth as a location-specific advantage (pp. 44-45), while Cho (1985) treats relative market size in the same way (p. 77). 54. The presence of subsidiaries of firms a bank deals with in its home country has been cited as a location-specific advantage in previous studies applying Dunning's eclectic theory to multinational banking (Gray and Gray, 1981; Cho, 1985). The specific motivation cited is usually the desire to preserve accounts by preventing other (usually host-country) banks from investing in overcoming the MNB's information advantage by making a one-shot investment in, in effect, "getting to know" the firm. However, as this statement of the argument makes clear, home country FDI is simply a proxy for the O S A the bank has by virtue of its stock of information on its clients, and hence is not a true L S A . A true L S A is something which affects the relatively desirability of serving clients from one country or the other (Dunning, 1979, p. 275) (see Section 2.2.2.3 for a discussion of this OSA). 46 Sheer market size or rate of growth does not, however, provide any rationale in itself for serving a market from a host rather than home location. While it is true that in large markets there is a greater probability that any niches will be large enough to support an operation of minimum efficient scale, the question remains why an M N B would find a host country location preferable. It is necessary to probe more deeply to fit market growth/size into the eclectic framework. The most immediate explanation for the influence of market size and growth is essentially related to a simple breakeven-point approach: if a market is small, one can fly there occasionally to look after one's affairs, but at some point the rent on an office becomes cheaper than the cost of telexes and airplane tickets. This exposition, however, makes it clear that the real driving force is communications costs, not size per se (see section 2.2.3.3 re communications costs). Growing markets also attract attention because size and growth signal that there are probably profitable opportunities for many potential entrants. Why is this? One possibility is that expanding markets may make it difficult for incumbents to coordinate their oligopolistic behaviour as traditional price-quantity relationships are upset, thereby reducing the probability of retaliation against newcomers. Incumbents may also not be able to increase capacity immediately (Tschoegl, 1987), resulting in shortages which push up prices and make buyers more willing to try new products and substitutes. This possibility is particularly attractive to MNBs, since they can easily shift funds and personnel to places where they are in demand. Moreover, when credit is short due to market expansion (or monetary stringency, for that matter) the costs of being foreign may decline as companies become more willing to deal with new bankers with new, possibly unorthodox methods of operation. At some point these costs may even become 47 negative, if dealing with a foreign banker is perceived as the mark of the rapidly growing, progressive company. These factors would provide some theoretical justification for Terrell's (1979) assertion that "it is easier to enter and expand in a large and growing market than (in) one that is stagnant or declining" (p. 20), an assertion for which he found some empirical support in his study of bilateral U.S.-Japan banking relations. Markets which are growing rapidly because of deregulation or technological innovation may also offer important learning opportunities. It has been suggested that this may be an important reason why many banks locate in the United States and in London. 2.2.3.2 Cost of Immobile Inputs Many of the inputs required for the provision of bank services, such as computers and money, can easily be moved from one country to another. Others, however, are more or less immobile, such as office space and labour, whose mobility is restricted by work permit regulations, language barriers, etc. The relative costs of these inputs affect decisions regarding whether to serve a foreign market from the home or host country, or a third country for that matter. In most cases the cost savings a foreign bank can realize in this area are probably not large enough to affect location decisions that strongly, because such banks tend to deal in relatively large wholesale or corporate transactions which require relatively little processing. For some types of transactions, however, cost savings can be significant. For example, "footloose" transactions such as the booking of Eurocurrency loans can be done almost anywhere. When there is more than one low to zero tax location available in a suitable time zone with adequate communications and transport links, the availability of 48 cheap skilled labour and office space may be a deciding factor. This may explain, for example, the proliferation of offshore banking units in Manila's Makati district before the recent political instability which has affected the Philippines. 2.2.3.3 Regulation Although it is difficult to agree with those such as Dale (1984) who state that "multinational, as distinct from international banking, may more accurately be described as an artifice born of regulatory anomalies than as a natural economic phenomenon rooted in comparative advantage" (p. 1), regulation is certainly a powerful influence on the multinationalization of banking. It affects the relative desirability of serving client needs from home or host country locations in several ways. Certain banking centres (e.g., the Bahamas, the Cayman Islands, etc.) probably exist only because of low taxes and confidentiality laws. Bank branches there are often no more than legal fictions, brass plates on an attorney's door (Grubel, 1985). According to statistics quoted in Dale (1984, p. 8) such "booking centres" accounted for 18% of M N B branches, 20% of subsidiaries, and 13.7% of affiliates in 1978-79. Their importance has probably declined slightly since then as more countries (e.g., Canada, Australia, Spain, etc.) have opened up to foreign MNBs. 5 5 Most developed countries, however, have broadly similar corporate income tax rates, so it is unlikely that corporate taxation considerations are important for branch entry decisions in most of these cases. (High taxes also obviously cannot deter representative offices at all since their loans must by law be booked offshore.) It is quite possible, however, that such factors may 55. Between 1980 and 1985, for example, the number of offshore banking centre offices of the 100 largest banks declined by 29 while the total of foreign offices increased by 147 (United Nations, 1988, p. 114). 49 introduce some degree of bias into the measurement of balance sheet growth and profitability in high-tax locations due to the incentive to book loans in offshore tax havens where feasible. (As will be discussed below, however, there are offsetting incentives to report the transactions in the host market.) Withholding tax, on the other hand, may encourage overseas branches by making cross-border lending an unattractive alternative. It has often been argued that U.S. banks in particular were pushed abroad by regulations which both prevented domestic expansion by prohibiting interstate banking and ruled out overseas lending from the head office through capital controls (e.g., Brimmer and Dahl, 1975; Roussakis, 1983, pp. 10-12). While this is an intuitively appealing explanation, other location-specific factors must either have been more important than or have evolved to replace these regulatory barriers as their removal did not lead to a precipitous decline in the number of overseas offices of U.S. banks. Regulation may also influence home vs. host country location decisions by restricting cross-border capital flows in other ways.56 Some borrowers may be forbidden 56. Regulations can also sometimes strengthen ownership-specific advantages by denying competitors access to opportunities they might otherwise pursue. For example, while almost all countries regulate the entry of foreign banks, some also regulate the pace of their own banks' expansion abroad. (See Pecchioli (1983, p. 54) for a summary of such regulations for 18 developed countries.) In some cases (e.g., Japan, Sweden and India) these regulations have been very limiting at times (Tschoegl, 1987). When some of a country's banks are allowed to open branches but others are not, the favoured have an incentive to open branches they might not otherwise have found viable because their country-specific advantages may be the best available substitute for the bank-specific advantages the less favoured would have offered to clients in the host countries. Branches which would have eventually been opened anyway may be opened sooner. Japanese banks would seem an excellent example of this phenomenon. The Bank of Tokyo was long given favoured access to foreign markets over the major city banks. The latter, in turn, were favoured over the trust banks. Regional banks have only quite recently been allowed to expand overseas. Many Japanese companies, preferring a Japanese bank overseas for linguistic, cultural and other reasons, have dealt with the Bank of Tokyo or another Japanese bank as the closest available substitute for their 50 to borrow from or deposit with institutions outside their borders, and hence need to be served locally. Similarly, restrictions on inward capital flows may make banks one of the few vehicles for the acquisition of assets in certain countries.57 If investors are prevented from directly acquiring assets in such countries, and banks can do so only by opening branches or subsidiaries, MNBs may be able to add value for their shareholders by overcoming such regulatory barriers. As barriers to FDI and portfolio investment have fallen, the importance of this motivation has no doubt declined, if indeed it was ever significant. As noted earlier, however, there are other reasons why banks may benefit from international diversification (see Sections 2.2.2.3 and 2.2.2.4). A number of writers (e.g., Yannopoulos, 1983, p. 249) have argued that a desire for access to an assured supply of key or "vehicle" currencies such as the U.S. dollar may push banks to open in countries which issue these currencies. To the extent that this motivation comes from a desire for access to a lender of last resort in the currency involved, it is also a result of regulation, since central banks typically restrict their support to institutions within their own market. Another way in which regulation may give rise to foreign investment is by creating blocked (i.e., non-repatriable) funds. It has been suggested that finding a use for own. The Globe and Mail (May 15, 1989, p. B28) has also reported that the Bank of China is rapidly upgrading its international network to pre-empt expansion by other P R C banks expected to receive permission to expand overseas soon. A quote from an unnamed official is revealing: "... BOC's strategy is to win more 'castles' before other state banks are finally allowed to go ahead [and to] establish our name and business throughout the world... It's a well-understood internal policy. We'll open as many branches as possible." 57. Approximately 100 closed end mutual funds have been authorized to invest in relatively closed L D C capital markets, but their total value is only about 1.2% of the capitalization of these countries' stock markets (Globe and Mail. October 12, 1989, p. B4). 51 blocked drachma profits was behind the development of the Bank of Nova Scotia's unusual three-branch network in Greece. More recently, debt-for-equity swaps seem to have encouraged some investments banks might not otherwise have undertaken, such as Scotiabank's acquisition of a 39% stake in Solidbank in the Philippines (Globe and Mail. July 7, 1987, pp. B1-B2; Financial Post. September 12, 1988, p. 46). Entry into the banking industry is typically highly regulated, even for potential domestic entrants (Dale, 1984). Such regulations may erect barriers to entry that create an oligopoly whose members reap supranormal profits. Outsiders would then have a powerful incentive to join the local oligopoly by seeking a banking license, particularly if others could be kept out. The effects of entry-limiting regulations on growth and performance are likely to be mixed, however, depending on the oligopolists' reaction to the new entrant. If they attempt to assert dominance through retaliation, both growth and performance are likely to suffer. If, as seems more likely, the oligopolists accommodate the newcomer, it may have to limit its growth (and hence total, though not percentage) profits to avoid retaliation. This may lead to an optimum size which trades off branch-level economies of scale and almost guaranteed short-run profits from expansion against medium-term risks of provoking a competitive war or restrictive regulations to protect the domestic institutions, which may be none too efficient if the oligopoly has become too cozy over time. Even if entry to a host market is free, uncertainty regarding whether it will continue to be in future can result in strategic decisions to enter early rather than take the chance (U.S. Department of the Treasury, 1979, p. 119). This line of thinking appears to have been behind the massive expansion of First National City Bank (now Citibank) in the 1960s under Chief Administrator Walter Wriston: 52 Wriston's philosophy of branch expansion was simplicity itself: to be everywhere there was a reasonable chance of turning a profit. He reasoned that many countries open to First National City would not remain so. Sooner or later, the combination of nationalism and resistance by local banks would exclude latecomers (Cleveland and Huertas, 1985, pp. 262-263). This phenomenon does not appear to have been confined to the 1960s: Damanpour (1986), for example, has ascribed the large increase in the number of foreign banks in the U.S. in 1978-79 to "fears of further restrictions on entry into the U.S." (p. 38), as has Walter (1985, p. 93). Similar moves now appear to be occurring as non-EC banks seek to ensure they will not be frozen out of the European market in 1992. One reason why the possibility of future entry barriers may encourage entry is that the economic future of many countries in the world is, or has been at certain times, highly unpredictable. Korea, for instance, has progressed from being on a par with India in the 1950s to being a middle-income country today. Argentina, on the other hand, has gone from wealth in the 1940s to near bankruptcy in the late 1980s. Since there is little reason to believe banks are any better at such long-term forecasting than anyone else, they may take advantage of opportunities to establish branches even when the immediate operating environment is not entirely favourable due to regulation or the state of the economy. Doing so is much like buying an option on the right to do business there in future. If the economy flounders, the option is worthless and the bank withdraws, as the Royal Bank did, for instance, in Guyana and Haiti (Financial Post. May 29, 1989, p. 8). On the other hand, if the economy booms, a bank with a branch will be "in the right place at the right time" (Wilmouth, 1976, quoted in Fieleke, 1979). Regulators would also likely attempt to keep these supranormal profits within the host country, either by negotiating a quid pro quo for entry (e.g., commitments to enter socially desirable but commercially unattractive lines of business) or by admitting so 53 many foreign banks that such profits are competed away in the areas where they are allowed to participate. Both options, for example, seem to have been used in Australia. After unsuccessfully encouraging foreign applicants to propose establishing branches to improve rural service or make some other contribution to the country (Tschoegl, 1987), the authorities proceeded to grant so many more licenses than originally announced that at least one bank declined to take up its license (Euromoney Supplement, May 1987, pp. 104, 110). Reduction of foreign profits through intensified competition may also have been behind the granting of large numbers of banking licenses to foreign banks in Japan during the impact loan period, when regulators may have wanted to drive down the abnormally high margins foreign incumbents were earning from their de facto monopoly on such loans. 2.2.3.4 Information and Communications Costs Information is one of the key inputs in financial industries, and it is therefore likely that differences in its availability and in the costs of transmitting it are important factors determining the location of financial activity. Mr. Michael Urkowitz, an executive vice-president at Chase Manhattan, for example, has been quoted as saying that "availability of information defines whether a bank is global or not" (Economist. March 25, 1989, Survey, p. 39). A similar view has been expressed by the former chairman of the Bank of Montreal, William Mulholland: "banking today is less and less about money and more and more about information" (Globe and Mail. September 15, 1987). To go beyond these generalities, however, one must identify the different types of information which are useful in banking, how expensive each type is to obtain from different locations, and how each is affected by communications costs. Four main types of banking information can be identified: background, commercial, technical, and trading. 54 Background information concerns economic forecasts, long-run political and social trends, cultural characteristics, and the host of other background data that provide an understanding of the local business environment and its evolution. It also includes such things as details of customers' pursuit of project work abroad (which will generally have a long gestation period before it results in business opportunities) and identification of major projects which might result in lending opportunities or offer potential for home-country client involvement. Information of this type is available in large volume, is relatively public and time-insensitive, and has low value per item because much of it is unreliable due to its often speculative nature and the conflicting opinions of experts. These characteristics mean that it is relatively inexpensive to collect and that relatively slow (and hence inexpensive) means can be used to transmit it. The key steps in its use are screening, validation and interpretation to make it useful. In most cases it is probably adequate to rely on the screening of natural cost-of-communications barriers which mean that only a subset of the information available in country A is packaged by the media and made available in country B. However, if the volume of business done in country A is very large, or if it has poor communications links with B, it may be worthwhile for a bank from country B to establish a listening post in A . This function can most easily and economically be achieved by a representative office, as a branch will provide little incremental benefit in the gathering of information of this type. The relatively low importance of this type of information in determining office patterns is supported by Nesper's (1984) finding that the introduction of satellite technology did not result in major changes in the degree of office dispersion: if the need to collect this type of information first hand had been an important reason for opening branches, we would have expected to see a decline in dispersion (ceteris paribus) once the costs of 55 transmitting it declined. Commercial information, including up-to-date knowledge of the banking needs of host-country corporations, both locally and overseas, has quite different characteristics. It is usually highly confidential and available in relatively small amounts (at high cost) from easily identifiable, but often relatively inaccessible sources, such as controllers, vice-presidents of finance, etc. Timing is usually of intermediate, but occasionally vital, importance, and the information has high value per item because of the profits available from servicing these banking needs. A l l of this implies that unless the host is close enough to be serviced by frequent visits, any significant gathering of commercial information will likely require a representative on the spot, although not necessarily a branch. A branch does however offer certain advantages in monitoring borrowers, in that frequent operational contact with clients provides earlier warnings of any untoward developments. Unlike background information, much commercial information is likely to require face-to-face meetings to evaluate top management, and hence to favour the establishment of overseas offices. Technical information involves the how-to of providing banking services. While the basics of banking are in the public domain, state-of-the-art information is usually highly confidential, constantly evolving, and embodied in people. When it is available in written form, it often lacks key details. Often full transmission from one person to another can be achieved only through learning by doing.58 In the very early stages of the product life cycle, such information may be known only to the innovator; however even in the later stages a newcomer may require considerable trial and error to master a 58. A n example of such information would be knowledge of how to create new financial instruments using swaps, options, etc. 56 mature technology with which it is not familiar. The nature of this technology diffusion process almost certainly mandates an operating presence (branch) in order to learn by doing and have access to a critical mass of experts. As a survey of international banking concluded: "among big banks there is an abiding fear of being left behind," which motivates international expansion by bankers who worry that "it may be risky, costly, and unprofitable, but if our bank doesn't do it, it'll be a has-been and won't have the expertise for whatever is the next trend" (Economist. March 26, 1988, p. 65). The final type of information is trading information, which is that required for participating profitably in foreign exchange and money markets. Trading information is extremely time sensitive, and may become stale after only a few minutes, or even seconds (Euromoney. May 1989, p. 114). Banker's Trust, for example, invested heavily in software to give its foreign exchange traders a 10 second advantage, since this was enough to make 3 or 4 trades before the rest of the market "caught up" (Office of Technology Assessment, 1989, p. 214). Because large positions can be taken based on such knowledge, it has very high value per unit. Although it normally comes from routinized sources such as wire services, it may first make its way into the market without formal announcement and need to be inferred from patterns of activity of other market players. The timing of release of such information is often essentially random, since markets can be moved by such a broad range of different information, from financial scandals to threats of war in some far-off part of the globe (Euromoney. May 1988, p. 66). This type of information probably gives rise to the greatest need for a local branch operation. Access to local-language wire services may give a slight edge over those who must await translations in the international services, but even more importantly banks must be aware of what other major market participants are doing and 57 this need can only be met by trading and talking with them constantly (Euromoney. May 1988, p. 69). Such information can therefore be very costly to obtain, and is very sensitive to time-related costs of communicating it. For all types of information, branches differ from representative offices in that they can not only gather information, but also act on incoming information. Thus the relative desirability of a branch vis-a-vis a representative office will be, in part, a function of whether information flows are uni- or bi-directional. In other words, banks from relatively economically unimportant countries may be able to make do with a representative office in a major financial centre because the information flow will be primarily from the IFC to the home country. Where the flow is more balanced, a branch may be able to make better use of the information flow from the home country to the host. 2.2.3.5 Signalling Having a banking license, a physical presence, and an operational capability may have benefits beyond those directly attributable to the day-to-day work of the branch. It can also provide signals to the market which yield benefits both locally and elsewhere in the bank. As Terrell (1979) observed: "each foreign branch and subsidiary contributes to the bank's profitability by enhancing the bank's ability to portray itself as a world-wide institution" (p. 19). These signalling effects provide both an L S A in favour of the host market and an incentive to internalize, since you cannot hire someone else to do something when the signalling effect is only caused by the fact that you are doing it. Some confirmation of the role of signalling effects is given in the following quote from the then President of Crocker National Bank: "If we are candid, we will recognize that many of those new offices, affiliates, and branches were added, not because there 58 was a proven market awaiting our talents nor because they were a logical extension of our bank's domestic activities, but rather for purposes of prestige or in the hope of being in the right place at the right time" (Wilmouth, 1976, quoted in Fieleke, 1979; emphasis added). Where the location is a major regional or world international financial centre, the externalities are likely to be particularly strong. When a bank has a branch in a major international financial centre, it conveys the message to borrowers, depositors, and regulators in other countries that the bank has both been accepted by the (presumably sophisticated) regulators of a sophisticated market and survived the intense competitive scrutiny of participants in that market. Conversely, pulling out of such a market conveys the message that the bank cannot make it in the big leagues of international finance. Not surprisingly, branch closures, always rare, are particularly so in major international financial centres. Tschoegl (1981a, p. 210), for example, found "exits" in California and Japan were almost always a result of either mergers which made an office redundant, acquisitions which forced divestitures for regulatory reasons, or the disbanding of a consortium in favour of separate representation for each participant.59 Davis (1979), moreover, cites interview evidence in which possible loss of "corporate prestige" (p. 114) is explicitly stated to have been a factor in senior management's refusal to close branches in London and other major market centres. Rationalization by Canadian banks, predictably, has resulted in closures concentrated in very peripheral markets such as Haiti, Dominican Republic, Trinidad, Guyana, Belize and Belgium. Only one branch closure was in even a secondary financial centre (Frankfurt) (Financial Post. May 24, 59. It will be shown below that the same is true in Korea and Japan, the countries under study here (see Tables 3-13 and 3-23). 59 1989, p. 3; May 29, 1989, p. 8). This pattern seems common: Hongkong and Shanghai Banking Corporation, for example, has cut back in such obscure markets as Fiji, the Solomon Islands, and Vanuatu (Annual Report, 1988) while expanding aggressively in Canada. Major multinational banks, on the other hand, are expected to be in at least the major international and national markets. In 1987, for example, it was reported that the Royal Bank of Canada, the country's largest, "must absorb the additional costs of being Canada's international standard bearer. It cannot pick and choose among international markets, as its Canadian competitors do, without calling its image into question" (Euromoney. November 1987, p. 50). For these banks, then, entry alone is not enough. To maintain, let alone enhance, their standing, they must be high in the pecking order of foreign banks. If financial statements are published, they must rank highly when compared to others; if they are not published, then their success must be made visible by other means, such as large staffs and expensive, high-profile offices. A bank must, in a sense, decide how much prestige it can afford, and hence whether its standard of comparison should be other MNBs from its home country or the top or second-tier MNBs world-wide. In any case, the externalities associated with perceived success may cause the bank to grow beyond the level dictated by short-term profit considerations alone. Smaller banks, on the other hand, may be able to satisfy the objective of prestige by association with only a minimal presence, the existence of the branch alone being adequate. Thus, besides lacking the pre-requisites for growth, smaller banks may lack the motivation to grow beyond a token, break-even presence. Government-owned banks may be particularly prone to opening branches on the basis of signalling effects. A country whose economy relies heavily on capital inflows 60 from abroad may find it beneficial to operate bank branches in important creditor financial centres, where their readiness to place deposits signals the home country's continued financial strength. Branches may also be established for political or diplomatic reasons which contribute little to their later growth and performance. Tschoegl (1987), for example, refers to "flagship banks with a strategy of representation around the world in any country of importance to the home country," giving the Korea Exchange Bank and State Bank of India as examples (p. 81). More recently, it has been announced that "in the spirit of perestroika, executives of the Soviet Bank for Foreign Economic Affairs are preparing to open the first U.S. office of a Soviet bank" (Globe  and Mail. May 26, 1989, p. B20). Signalling effects may have a major influence on the types of markets a bank chooses to enter. Regional financial centres such as Singapore, Miami or Bahrain may be particularly attractive to relatively unknown banks as a stepping stone to the more prestigious world financial centres such as London, Tokyo and New York. Once a bank has established branches in the "Big Three" locations, additional regional centres should bring little in the way of increased legitimacy of the type described immediately above, but may reinforce the commitment to individual national markets in the region signalled by branches in them. Regardless of location, having a branch in a market signals a strong commitment to it because of the large, mostly irretrievable investment that must be incurred in terms of training and equipment costs, start-up costs, leasehold improvements, etc. It would appear that banks are consciously aware of the need to make such expenditures, since the Hongkong Bank of Canada reported that in 1988 "many branch interiors were upgraded... to reflect our long term commitment to Canada" (1988, p. 6). Moreover, Mr. 61 John Reed, Chairman of Citibank, took advantage of the opening of a precedent-setting second branch in Seoul just months after moving into the first foreign bank-owned office building in Korea to state that "While many international banks go back to their home countries, we are becoming more a part of the local banking community" (Korea  Business World. May 1988, p. 18). Eaton (1986) has emphasized that when it is costly to enforce loan contracts, lenders may withdraw from the market because they cannot make credible threats to pursue delinquent debtors. By changing the calculus of costs and benefits associated with collecting delinquent foreign loans, the establishment of overseas branches may help to deter borrowers who might otherwise consider them "easy marks." Host governments may also prefer to direct business to those foreign banks which have demonstrated "an 'interest' in the welfare of the country" (Lees, 1974, p. 62) by establishing a branch. 2.2.4 Network Economies: The Interaction of Ownership- and Location-Specific  Advantages Until now OSAs and LSAs have been discussed separately, with the implicit object of analysis being the decision to enter a single foreign market viewed in isolation. However, a more sophisticated view looks instead at overseas offices as part of a coherent network. It matters not whether management has the foresight to take this view at the outset, or whether it evolves later, perhaps even subconsciously. The important point is that having branches in a variety of overseas locations changes the calculus of costs and benefits of locating in any individual overseas market. Under certain circumstances, the benefits to having a network of x branches may exceed the sum of the benefits that would accrue from each branch individually. One example of how this can occur is the case where country A's banks are not 62 represented in country B and vice versa (perhaps, for example, because there is a lack of reciprocity), but a bank from country C has access to both markets. Such a bank can use its advantageous nationality to open branches in both A and B and exploit any A -B inter-market opportunities that may arise related to trade and investment between the two countries. It may do so even when the A - C and B-C connections themselves are insufficient to warrant opening such offices. A n example of how foreign banks can serve to link two hosts is given by Wright (1987, p. 17), who reports that Canadian banks in Japan have profited from their strength in the Caribbean, as Japanese banks are not represented there, and Caribbean banks are also absent from Japan. Another illustration relies on the fact that operating a branch in an overseas market for a lengthy period will eventually give a foreign bank a knowledge of local culture and business practices rivalling that of indigenous banks (see Section 2.2.2.4). Such knowledge then lowers the barriers to doing business in countries with related cultural and business practices. This tendency may have favoured the expansion of the several American banks which built up large networks in Latin America. Familiarity with Chinese business practices from a branch in Hong Kong may also have lowered foreign banks' costs of entry into other South East Asian markets where, despite radically different indigenous cultures, much of the commerce remains dominated by overseas Chinese.60 Network economies also occur because each banking centre is linked not only with a bank's home city, but with many others as well. Locating in one therefore gives access to information which can be acted on profitably in several other places. Similarly, many 60. See Landa (1981) for an interesting theory regarding the reasons for this dominance. 63 other centres generate information which creates profit opportunities in the host. A bank which has branches in a number of locations overseas will therefore have more information which can be used profitably in a given host, and more opportunity to make use of that which is generated there. It will also have greater opportunities to profit from other market imperfections, each of which individually may not have been sufficiently important to warrant establishing a branch. Concentrating a branch network in one region can generate network economies in several ways. Countries which are geographically close will generally tend to have similar cultural and business practices (see above), and be joined by trade and investment flows (see below). To the extent that geographical proximity facilitates interaction among branch managers within a region, they can share insights into dealing with regional problems. Even if they are not able to meet, a regional executive or regional office may act as a clearinghouse for new strategies for coping with common regional problems. Finally, travel and communications expenses necessary for supervision by head office may be lower when branches are "bunched" together rather than spread around the world. These factors may explain why many banks tend to concentrate their branches in one or a few regions, apart from the IFCs they feel they need to be in. Canadian banks, for example, dominate the Caribbean. A number of U.S. banks have large networks in Latin America, while French banks tend to have large numbers of branches, subsidiaries and affiliates in Africa, as do British banks, which are also heavily represented in Asia. The nature of the links which will yield network economies will vary from bank to bank, depending on the nature of the institution's OSAs. These OSAs may be in any of the three main activities involved in banking: lending, payment processing, and trading. 64 Each area of expertise will be associated with exploitation of a different type of link. Banks whose OSAs give them an advantage in lending will of course be attracted to high growth markets, whose borrowing needs are likely to be the greatest. At this level, however, each country can still be regarded individually. Opportunities for network economies appear once such a country begins to invest abroad. Both home country banks and others are likely to be attracted by the borrowing needs of subsidiaries, so that countries which play host to FDI from the given home country will be good candidates for MNBs seeking to open offices to form an integrated network within which information on the borrowing needs of one subsidiary (or the parent) favours development of relationships elsewhere in the network. Other banks develop special expertise in the processing of international payments by means of wire transfers, letters of credit, clean and documentary collections and so on. Since most such payments relate to trade, coherent networks of branches for such institutions are likely to parallel import and export flows. Trading activities have also become a major activity for most leading banks today. Trading may involve foreign exchange, bonds or other money market instruments. While many foreign exchange transactions are still trade related, most are investment- and speculation-driven,61 as is the case with the other instruments mentioned (Euromoney. May 1989, p. 81). Short-term investment flows are thus likely to provide the best clue to constructing a coherent network for banks with trading-related OSAs. Finally, as discussed elsewhere, establishing a banking relationship is a costly affair. Not only is there considerable uncertainty (see Vernon's discussion of Dean and Grubel, 61. Only 10% of current foreign exchange trading volume is estimated to be related to trade (Globe and Mail. September 14, 1989, p. Bl ) . 65 1979, p. 442), but one must devote a large amount of managerial time to initiating and continuing the flow of information a bank requires for lending decisions. Companies thus have an incentive to minimize the number of banks with whom they deal. (Obviously this incentive must be balanced against possible benefits of dealing with many banks, such as greater information flow and access to financial innovations.) A n M N C should therefore seek one or a few banks that closely match the pattern of its overseas expansion and can supply the services which local banks may not provide efficiently. A foreign bank which has a matching network of branches may therefore be attractive enough to a host-country firm to overcome the cost of being foreign. Local banks clearly cannot have a network which matches the needs of every one of their clients, so they lose some of their business to the banks whose networks provide the best fit to local businesses' overseas subsidiaries.62 This discussion of network economies reveals something of the complex interaction between location-specific and ownership-specific advantages: a location-specific advantage leads a bank to open a branch overseas; this gives it an ownership advantage in information and experience which makes additional branches worthwhile; these branches compound the advantage; and so on until a coherent network is established. Of course, this optimal network will change over time with the ebb and flow of trade and investment patterns, so that a dynamic picture emerges. 62. The problem of which bank's network to "join" offers interesting parallels to the problem of which telecommunications network a subscriber should join. See, for example, the work on telecommunications by Katz and Shapiro (1985), Littlechild (1975), Oren and Smith (1981), and Rohlfs (1974). 66 2.2.5 Summary The sections above have identified a number of sources of competitive advantage for banks and determinants of where they will choose to produce financial services. This section briefly summarizes the conclusions of the foregoing analysis with respect to the conditions most likely to result in multinational banking. Size should be an important influence on a bank's incentive to expand overseas because large banks are better able to match customers with offsetting needs and thereby reduce search costs. Size also makes asset transformation less risky because of the greater stability of the need for a particular service when there are many rather than few customers. Large banks may also be better able to withstand start-up or cyclical losses and hence be viewed as having greater commitment to a market. Banks which have already entered foreign markets and achieved a degree of geographical diversification will be more likely to enter additional markets. They will have a sufficiently diverse customer base that they are likely to be able to find matches for most customer groups in the host market, and should have accumulated enough experience to reduce the burden of extra information production costs associated with being a foreigner. They also benefit from the "reputation" effects of having had their standing endorsed by multiple regulators and by success in multiple markets. Skill in asset transformation should lead to high market shares in high-value added, knowledge-intensive financial products which are closely tailored to meet the needs of borrowers or depositors. Banks from countries with highly-developed banking sectors are most likely to have such skills, and those which have expertise in these areas should be tempted overseas by the opportunity to exploit their knowledge in new markets. When many of a bank's customers have moved to a host country, a bank will have 67 a readily accessible base of customers which it can easily recapture because it can produce information about and monitor them at lower cost than local institutions. Large volumes of international transactions with a host country will also present tempting opportunities. Strong capitalization confers greater value on a bank's certification of borrowers because the bank is prepared to "put its money where its mouth is." Local borrowers should therefore be keener to deal with such institutions, particularly when they want access to capital markets in their (the banks') home countries. Depositors, of course, will also prefer such banks because the capitalization is a sign that the bank has strong assets and hence is likely to be able to repay funds without the delays and uncertainty which prevail when even insured banks must be wound up. The effects of regulations on location decisions are complex due to the level of detail necessary for a thorough analysis of the net advantage or disadvantage they confer on the production of financial services in one place or another. However, low taxation on local income, high withholding taxes and other barriers to cross-border transactions by residents, limitations on non-resident access to important currencies, oligopoly rent-generating entry barriers and uncertainty about future freedom of entry should all make a country more attractive as a host to foreign banks. Distance, which affects communications costs and hence the cost of monitoring borrowers and the ability to be at the leading edge of fast-moving international financial markets, can reduce the desirability of a potential location. The extent of its impact, however, will depend on the type of information a bank needs to obtain for the type of business it wishes to do in the prospective host country. Finally, the relative cost of purchasing heavily-used inputs may affect location 68 decisions in some cases. Such influence is likely to be strongest on relatively "footloose" types of banking business such as that conducted in the various tax-haven "booking centres" around the world. While the above discussion highlights the broad "macro-level" factors likely to encourage the multinationalization of banking, at the micro-level each bank must consider how receptive the prospective operating environment is likely to be to its specific bundle of advantages. This evaluation may differ widely across banks due to the variety of activities lumped together under the heading "banking." This variety in turn offers considerable scope for very diverse banks to find a market attractive and suggests that strategic groups,63 or groups which consists of banks "following similar strategies in terms of the key decision variables" (Porter,1979, p. 215) may be a more appropriate unit of analysis for micro-level studies than the industry as a whole in many markets. The interplay of the factors listed above should determine to a large extent the answers to questions about multinational bank behaviour such as: (a) why some banks enter a host market earlier than others, (b) whether banks which enter a host market with different forms of representation are responding to the same or different forces, (c) what determines the success of a bank once it has entered an overseas market, and (d) what determines the identities and order of the countries a particular bank chooses to enter. 63. , Porter (1979, p. 215) and others have ascribed the first use of this term to Michael S. Hunt in his unpublished 1972 doctoral dissertation "Competition in the major home appliance industry, 1960-70" (Business Economics Committee, Harvard University, May 1972). 69 While no single study can hope to provide definitive answers to all these questions, the following chapter will outline methodologies and data and present the specification of testable models of bank entry and performance which should provide insight into several of them. 70 Chapter Three M E T H O D O L O G Y 3.1 Introduction The previous chapter ended with a series of questions which a theory of multinational banking should be able to answer. In order to investigate all of Chapter Two's questions empirically one would require a multi-bank, multi-host country design. Unfortunately, for analysis of bank- (rather than country-) level factors the data collection exercise necessary for such a study would quickly become very daunting. For example, if one wished to examine the behaviour of 300 banks in 30 countries, there would be 9,000 cells to be coded from a variety of source documents just to determine who was where in a given year.64 This study can therefore not investigate all of these questions. A pair of multi-bank, single-host designs can, however, provide insight into at least three of the four questions, i.e.,: (a) why some banks enter a market earlier than others, (b) whether banks which enter a host market with different forms of representation do so for similar or different reasons, and (c) what determines the success of a bank once it has entered an overseas market.65 The question of a bank's selection of countries from among the possible universe of hosts will therefore be left to future work. The subsections that follow will first 64. This data collection problem has been recognized by previous researchers such as Heinkel and Levi (1989a). 65. As noted in Section 1.4., this study is the first to use a sample of banks from many home countries and focus on individual non-U.S. markets. 71 introduce statistical techniques and data that can be used to develop empirical models for the investigation of each of the other questions, and then provide the institutional background necessary to generate specific predictions which can be tested. The next chapter reports the results of the tests. 3.2 The Timing of Entry The question of why some banks enter a given market earlier than others essentially seeks to identify the characteristics that affect the time until a bank makes the transition from one state (i.e., not having a branch) to another (i.e., having a branch). The class of techniques most suited to researching such questions is called survival-time or failure-time analysis. While these techniques originated in biomedical and engineering studies, they have been used in studies of other aspects of bank behaviour before, as will be discussed below. The inference pattern used here links the cost-benefit calculus of entry to its timing, that is, prognostic models of entry are developed by relying on the assumption that the banks with the strongest advantages will be the first to enter (i.e., open a branch).66 This assumption seems reasonable since banks with the strongest competitive advantages could expect to earn the highest profits. With the most to gain, they are likely to be the most active in lobbying for the opening of a market and hence be among the first to receive a license. Even after a market is opened, they are likely to be more 66. The models are prognostic in the sense that they attempt to identify the variables which will "predict" early entry, for example. They are not dynamic models since they do not deal with the interactions of variables over time. The intent here is similar to that of a researcher attempting to identify the variables which predict the finishing times of horses in a race based on characteristics observable at the starting gate, rather than to that of a researcher concerned with how early events during a race affect later events and eventually the outcome. 72 willing to take the high risks associated with being an early entrant.67 Banks with weaker advantages (and hence profit prospects) may then follow as uncertainty about the market is resolved or reputation and information gathering advantages from presence in the market increase to sufficiently high levels to justify their presence on the basis of externalities favouring other parts of the bank's network. In order to discuss the specific technique chosen here a few terms must first be defined.68 If T is a random variable representing the "lifetimes" (times to transition) of banks in a population, f(t) is the probability density function (p.d.f.) of T, and the distribution function is: t F(t) = Pr(T<t)= J o f(x)dx, (Eqn. 3.3.1) then the survivor function, which gives the probability of a bank remaining in state one ("surviving") until time t can be defined as: S(t) = Pr(T>t) = J , f(x)dx (Eqn. 3.3.2) The hazard function, which gives the instantaneous probability of transition into state two at time t, given that the bank has remained in state one until time t, can also be defined as: 67. If their own entry (but not that of others) is restricted by reciprocity requirements, the role of the underlying economic factors should still not be altogether lost, since one would expect the banks with the greatest potential for growth and profit in a host country to be prepared to spend the most lobbying their home governments for appropriate regulatory changes at home and to start their lobbying sooner. Tschoegl (1981b) found some evidence consistent with the former conclusion, in that "countries with two or more world-class banks tend to be less restrictive [in regulating foreign banks - T.U.] than those with fewer" (p. 28). 68. This discussion closely follows that of Lawless (1982). 73 h(t) = lim Pr (t <T < t + *t | T >t) A H ) ~_ (Eqn. 3.3.3) At S(t) Survival analysis techniques are of two types: parametric and non-parametric. Parametric techniques assume some distribution of lifetimes T and give a specific functional form for the hazard function. Different parameter values can be substituted into these forms to generate hazard functions with shapes appropriate to the purpose at hand. Non-parametric techniques, on the other hand, do not assume any particular distribution. Because this freedom from distributional assumptions can be had at very little cost in terms of efficiency (Lawless, 1982, p. 344), this study uses one of the more widely-used non-parametric methods, the Cox proportional hazards model.6 9 If x is a vector of variables which are associated with a bank's lifetime (i.e., time in state one)70 and & is a vector of unknown parameters, Cox's model has h(t|x) = ho(t)exp(xB) (Eqn. 3.3.5) where h0(t) is the baseline hazard function of a bank with x = 0. No assumptions are made about the form of h0(t); however, the model assumes that the variables in vector x have a multiplicative (log-linear) effect on the hazard function. 69. Technically, the Cox model should be referred to as semi-parametric, since it depends on the vector of regression parameters 6: h0(t), however, is non-parametric, i.e., requires no distributional assumptions (Lane et al., 1986). The actual computations were carried out using B M D P routine 2L, which uses an iterative Newton-Raphson algorithm to maximize the partial likelihood function (Dixon, 1988, p. 733). 70. The bank's characteristics are relevant here rather than those of the host market (e.g., the profitability of incumbents) since only one market is modelled at a time. A l l potential entrants therefore face the same incentives to enter the market, i.e., market characteristics should not have any discriminating power. 74 For the Cox model, which uses a continuous probability density function, to be applicable, theoretically there should be no ties in the data. (A "tie" occurs when two individuals move from state one to state two at the same time.) However, in practice, ties often do result because of lack of precision in the data. Fortunately, in most cases here there are no ties because the exact day of transition can be identified. (When there are few tied observations, random breaking of ties is usually sufficient (Kay, 1977, p. 228).) Any exceptions will be noted as they arise, since a large number of ties may lead to unreliable results. A n observation in survival data is called "censored" when the individual has not made the transition from state one to state two by the end of the time period in which it is under study. Censoring may have many causes: withdrawal of an individual from an experiment, termination of the experiment before all individuals involved have made the transition, etc. For the Cox model to be used, one must assume that "death" (transition) and censoring are determined by independent mechanisms and that the only information on the survival time t of an individual censored at t+ is that t > t+ (Kay, 1977, p. 227). In this application censoring will occur because the analysis must be performed before all banks have opened branches in Tokyo. This assumption is equivalent to saying that it is simply not known whether any of the banks that had not opened branches by the cutoff date will open them in the future, which seems a reasonable assumption. One of the most important issues involved in the use of survival time analysis to test the model of timing is the selection of the "base" (starting) year. In Korea's case, this is not too difficult. Foreign banks were not allowed to establish branches until May, 1967, when Chase Manhattan opened in Seoul. Assuming that before that date there 75 was at least a brief period during which banks were aware of the possibility that banking licenses might be granted, 1966 seems a reasonable choice. Japan's case is slightly more problematic. About a dozen banks, most of which had been there before the War, opened in Tokyo during the Occupation (1949-50). However, from then until 1969, only about seven banks were allowed in, mostly from small Asian countries where Japanese banks wanted to open. In March 1969, Morgan Guaranty's opening ushered in a new era of relatively liberal entry, which saw 45 banks open in the following decade. There are thus two possible starting dates, one in the late 1940s and the other in the mid to late 1960s. The latter course was chosen for two reasons. First, the de facto ban on entry from 1950 to 1969 would bias results based on the earlier date by overemphasizing the characteristics of the banks which reopened before the ban. Second, from a practical standpoint it is much easier to get reliable data from the mid-60s than from the immediate post-War period. Since most of the data do not change appreciably over a year or two, the study economizes on data collection resources by using 1966 for both countries rather than gathering 1966 data for Korea and 1968 data for Japan. The values of the elements of the vector of explanatory variables (covariates) x are typically assumed to be fixed at the start of a study.71 In this paper, however, one 71. For this assumption to be plausible requires three things. First, the mechanism generating entry decisions must remain stable over time. This assumption is necessary for the very idea of a theory of entry to make sense. Second, the regulatory process and other market characteristics must remain relatively constant. These issues were addressed by choosing a period which was characterized by relatively stability in entry regulation and conducting sensitivity analysis to determine whether the findings were robust with regard to the exact period chosen. Neither moving the beginning of the period back one year (to January 1, 1966) or forward three years (to January 1, 1970) nor bringing the endpoint up seven years (to 1980 instead of 1987) had any major effect on the results. A time-dependent covariate (discussed above) was used to accommodate the one major change in the regulatory environment of individual banks, i.e., whether 76 additional complication is introduced. Both Japan and Korea require foreign banks to obtain Ministry of Finance approval before opening a branch. Because a lack of reciprocity72 may have restrained some banks from entering, a time-dependent covariate [see Lawless (1982, pp. 392-394)] is introduced to account for these regulatory restrictions. This covariate is a dummy which assumes the value of zero until the bank is free to enter the host market73 and a value of one thereafter. Because the opening of representative offices is subject only to cursory regulatory restrictions, the study also cross-checks these results through the estimation of a timing model using representative offices rather than branches as the dependent variable. The Cox proportional hazards model has been applied to the banking industry in other contexts. Lane et al. (1986) and Betton (1987), for example, compare the use of discriminant analysis and the Cox model in predicting bank failures. This study, however, is the first application of the technique to the question of foreign bank entry. For ease of reference, this model will be referred to as Model I. a bank had the freedom to enter by virtue of reciprocity. Third, the values of the independent variables must remain stable at least in relative terms. This assumption was tested in two ways. First, calculating the correlations of the 1966 values of the variables with their values in three later years (1979, 1983, and 1986) showed that these correlations were generally high enough (>_ .8) to make this assumption plausible. Second, the analysis was run using 1983 values of the variables instead of 1966 values. The results were essentially the same. 72. With respect to foreign bank entry, reciprocity is a policy of allowing country i's banks into your country only if your banks are allowed into country i. The Japanese have traditionally followed such a policy in granting banking licenses. As the Federation of Bankers Associations of Japan put it in a 1982 commentary on the New Banking Law: "...in actual application of the law, the principle of reciprocity with the country from which the foreign bank comes will be given importance more than anything else" (cited in Semkow, 1987, p. 13). Korean officials have also taken reciprocity into account (Lee, 1980b, p. 4). 73. This is assumed to occur when a host country bank first establishes a branch in the bank's home country. 77 3.3 Forms of Entry During the period studied here, banks that wished to establish a presence in Japan or Korea had, in practical terms, a choice of two forms of operation: a branch or a representative office. Acquisition or the greenfield establishment of subsidiaries was not allowed in either country. Most of this study concentrates on the establishment of branch operations; however, it is important to determine whether the models developed here apply to representative offices as well. In other words, do banks establish representative offices for reasons similar to those motivating the opening of branches, or are other forces at work? To investigate such a question, a multi-group classification technique is required. These techniques fall into two broad categories.74 The first group, which includes multinomial probit models, deals with "ordered" choices, wherein a natural ranking of the possibilities is apparent. For example, the number of stars a critic awards movies or the ratings assigned to bond issues have "natural" rankings: higher numbers or ratings are always preferred to lower ones. The other group of classification techniques consists of those used to deal with "unordered" choices, i.e., choices where we cannot say a priori that one is "better" than another. Since there is no a priori reason to conclude that a branch is "better" than a representative office or vice versa, this discussion will focus on techniques for dealing with unordered choices.75 74. This discussion closely follows that of Altman et al. (1981). 75. Ordered choice models are very sensitive to the researcher's assumption regarding the ordering of the choices. Multinominal probit, one of the most useful of these techniques, also suffers from severe computational problems (see Altman et a l , 1981, p. 80). 78 The most common multigroup classification techniques for unordered choices are discriminant analysis and multinomial logit. In general, discriminant analysis is most suited to cases where the causality runs from the dependent variable to the independent variable(s) (Altman et al., 1981, p. 112).76 McFadden (1976b) has shown that with suitable distributional and a priori probability assumptions, discriminant analysis can be used when the causality runs from the independent variables to the dependent variable (as it does here), but given the sensitivity of discriminant analysis to the researcher's assumptions he nevertheless recommends an alternative technique in most cases. The technique used here is therefore the multinomial logit model. One of the strengths of the multinomial logit model is that it is consistent with an assumption of utility maximization by choice-makers. In the simple case here where a bank has a choice among no representation (choice 0), a representative office (choice 1) or a branch (choice 2), and assuming vectors of independent variables X and coefficients 6, a branch will be chosen if and only if X ; „ B 2 + > X ^ B , + e ln (3.4.1) and X 2 n B 2 + Cj. > Xo„B 0 + e0n and thus given the X's the probability of choosing a branch is P(branch |X) J™ J™ f ^ e j e J / ( e J d e ^ d e , , (3.4.2) where D 2 1 = X 2 n B 2 - X ^ B , + and Da, = X 2 n 6 2 -X 0 ' n 6 0 + 76. This would be the case if, for example, we were trying to predict sex based on height, weight and pitch of voice. In such a case it is clearly "maleness" that causes the average individual to be taller, heavier and have a lower voice, and not vice versa. 79 McFadden (1974) shows that if the e's are independently and identically distributed extreme value random variables, the multinomial logit model gives the probability of choosing choice i from among k possibilities as: P(choice/|X.) = exp (X'M ~~k (3.4.3) s exp(X;n6J) j = l To obtain this result, however, the assumption of "independence of irrelevant alternatives" is necessary. Thus, for all possible pairs of choices, the probability that one choice will be chosen over the other, given that one of the two must be chosen, must equal the relative probability that one choice will be chosen over the other when the entire choice set is available. In other words, the relative odds of one alternative being chosen over another does not depend on what other choices are available (Altman et a l , 1981, p. 75). In the problem investigated here, this is equivalent to assuming that, for example, the relative probability of a bank choosing to open a representative office rather than have no representation is the same regardless of whether it is possible to open a branch or not. This assumption seems quite reasonable here. There are two primary variants of the general multinomial logit model described above. The multiple data or conditional logit model is used when the independent variables are characteristics of the choices, while the multiple-weighting model is appropriate when they are characteristics of the choice maker. This study analyzes relationships between characteristics of banks and their choice of form of representation and hence applies the multiple weighting model. In this model the coefficients are subscripted by choices but the independent variables are not, so that equation 3.4.3 80 simplifies to P* = exp(X'A) k (3.4.4) 2exp(X^ j ) J' = l The coefficients in 3.4.4 must be normalized to identify them uniquely. Two normalizations are common. Nerlove and Press (1973) require the sum of the coefficients to be zero, i.e., k 2 bi = 0 (3.4.5) j = l while Theil (1970) picks one choice i as a base and sets 6, = 0. As Altman et al. (1981, p. 73) point out, "the choice of normalization does not affect the model 'fit' in estimation or choice probabilities"; however, for ease of interpretation Theil's normalization is used here. This method was also used in Kogut and Singh's (1988) study of the effect of culture on the choice of mode of entry.77 Banks which enter as representative offices could be doing so with the intention of remaining as representative offices or as the first step to opening a branch. To minimize this source of ambiguity one should examine a relatively mature market. By the mid 1980s the number of new foreign bank entrants into both Japan and Korea had slowed to a trickle, as will be shown in Section 3.6.78 The multinomial logit procedure will therefore examine the choice of form of representation in 1986, which was the latest year for which data were available when the data were collected. However, since banks 77. The actual computations were carried out using S H A Z A M (White et al., 1990) with the coefficients from a "first-pass" binomial logit estimation as the starting points for the iterative procedure. 78. See Table 3-2 and Figure 3-1. 81 do not respond instantaneously to changes in conditions, a lag needs to be incorporated to allow for the time it takes for a bank to open or close a branch once it has decided to do so. In practice it seems three to four years is long enough for a bank to open a representative office, evaluate the market, and lobby for a bank license. Banks which opened representative offices (which require little advance preparation) were generally able to open branches within this period if they chose to, and hence a three to four year lag is used here. In other words, 1983 values of independent variables will be related to presence in 1986.79 For convenience this model will be referred to as Model II. 3.4 Post Entry Competition Typically the technique used for analyzing performance has been some form of multiple regression. Table 1-3 provides examples of a number of studies which have taken this approach. For a number of reasons, however, the regression approach is unlikely to be optimal in this case. First, because all the banks in the sample available have sufficiently high levels of the independent variables to have found entry worthwhile, there is unlikely to be sufficient variation in the independent variables for them to be able to differentiate between high- and low-performance banks. Second, the sample sizes are fairly small (about 40 banks in Korea and 70 in Japan) relative to the number of variables of interest and as a result the power to reject the null hypothesis may be low. Third, the performance of banks may be as much a reflection of the niche in which they compete as a consequence of their competitive advantages. Fourth, if banks are competing in different niches, the importance of any given source of advantage may 79. As a check, 1979 values of the independent variables were related to 1983 values of the dependent variables and models without a lag were also estimated. Results were similar to the lagged results reported below. 82 depend on the bank's niche, e.g., advantage A may be important and advantage B unimportant for banks in niche one while for banks in niche two it may be the reverse. Finally, because the unit of study (in almost all cases a single branch) is so small, idiosyncratic factors such as the skills of a particular manager, or even the illness of a key employee, may often be of sufficient import to distort statistical results. In view of the above, a case study approach focussing on possible strategic groups among the foreign banks in the host countries was adopted. While the term "strategic group" is usually attributed to Michael S. Hunt's unpublished 1972 doctoral dissertation "Competition in the major home appliance industry, 1960-70,"80 it was the work of Caves and Porter (1977), who generalized entry barriers into "mobility barriers" between subsets of the firms in an industry, and especially of Porter (1979), which brought strategic group analysis to the fore. Strategic group analysis starts from the observation that "all firms in a typical industry are clearly not alike: they follow very different strategies along dimensions such as their degree of vertical integration, breadth of product line, etc." This approach proposes that understanding of the determinants of firm profitability requires that an industry "be viewed as composed of clusters or groups of firms, where each group consists of firms following similar strategies in terms of key decision variables." These strategic groups are important because those "that possess high mobility barriers, are relatively more insulated from rivalry by their place in the configuration of strategic groups, have superior bargaining power with adjacent industries, and face lower elasticity of demand with substitutes, will enjoy high[er] profits" (Porter, 1979, pp. 214-215). 80. Business Economics Committee, Harvard University, May 1972 (see, e.g., Porter, 1979, p. 215). 83 While previous work in industrial organization focussed on structural traits of industries, Porter suggested that intra-industry structure was also important. While he recognized that firm-level traits such as "scale within the strategic group," "differences in the cost of mobility into the strategic group" (due, for example, to early vs. late entry), and "the ability of the firm to execute or implement its strategy in an operational sense" (p. 219), could also affect profitability, it was largely left to later researchers to examine the reasons for performance differences among members of the same strategic group.81 The strategic groups concept has been applied to a wide variety of industries, from brewing to knitwear to investment banking.82 However, while groups are nearly always found in empirical work, in many cases the evidence for performance differences across groups is weak, possibly due to poor empirical operationalization of the strategic groups concept (Thomas and Venkatraman, 1988). Early researchers such as Porter (1979) used single variables as crude as firm size to separate firms into groups. Both the aforementioned reviews point to the need for operationalizations more closely related to actual strategic choices of a firm. Given that most studies to date have been single snapshots in time,83 there is also a definite need for greater attention to the temporal stability of the groups found and to "the evolution of group structures" (McGee and Thomas, 1986, p. 158). 81. See, e.g., Cool and Schendel, 1988; Lawless, Bergh and Wilsted, 1989. 82. See McGee and Thomas, 1986, and Thomas and Venkatraman, 1988 for helpful reviews. 83. Oster, 1982; Cook and Schendel, 1987, 1988; and Fiegenbaum and Thomas, 1990 being notable exceptions. 84 The approach taken here is to operationalize the strategic group concept through the use of major balance sheet items.84 The relative weights of these items indicate a bank's strategy choices and its success in implementing them, and have been used in previous strategic group analysis of the U.S. banking industry (Amel and Rhoades, 1988; Passmore, 1985). Since this will result in banks being grouped together whenever they have similar balance sheet structures, the common "strategy" which links them is their relative emphasis on where they raise funds and what they do with them. In particular, it should be recognized that banks linked together in this way may not necessarily be pursuing the same "strategy" in the sense of a common marketing approach or even a common target group of borrowers. For example, two banks could be in the same strategic group because both are heavily involved in lending, but not be competing with each other at all if one focuses on consumer lending using T V advertising and the other on corporate lending using a direct sales force. In practice, however, given the regulatory and structural impediments constraining the range of options open to foreign banks in Japan and Korea, there is much less room for such cases to arise than in a purely domestic environment, particularly when the banks within a group are from the same home country. Harrigan (1985) has addressed the differences between niches, which she calls "pockets of demand that possess a unique willingness to pay premium prices for certain attributes... and which cannot be served by all comers," and strategic groups, which "are comprised of firms who may compete for the same customers' patronage in diverse ways" 84. Inspection of the branch level data on the foreign banks in Japan revealed substantial differences in balance sheet structure and other characteristics (e.g., assets per employee). Such large differences suggest that a variety of operating strategies may have been adopted and hence that a strategic group approach may be appropriate. 85 (p. 56). This distinction is useful, if often neglected. However, the term "strategic group" will be used here in the more traditional sense of a group of firms with a common operating strategy, rather than a group with common customers. A strategic group, then, may be serving several niches. For example, in Canada one might argue that there is a strategic group of banks which pursue the business of immigrants from their home countries. Such banks would operate very similarly, yet each would be in a niche of its own protected by barriers of language, custom, nostalgia and perhaps lingering elements of patriotism.*5 One of the advantages of this approach is that it makes comparisons of profitability within groups more meaningful. In banking, cross-firm comparisons of profitability can be very misleading unless balance sheet structure is taken into account. This is because the nature of a bank's operations affects which measures of profitability it will excel on. For example, a bank which emphasizes transaction processing and has a low asset base will tend to have a higher R O A than a lending-oriented bank, even if it is not, in some sense, as "good" at what it does as the lender. Ideally a multidimensional set of criteria would be used in identifying the strategic groups (thereby eliminating such ambiguities), but such data were not available for all banks. However, because the object of this exercise is to determine whether some of the factors suggested in Chapter Two which could not be tested at the level of aggregation used in Models I and II are indeed important by analyzing their impact on the strategic group chosen by each bank and its success relative to other members of its group, a 85. For example, while one might expect the National Bank of Greece Canada to operate similarly to Korea Exchange Bank Canada, their customer bases are likely to have little overlap. 86 substantial amount of micro-level data gleaned from the trade press will be introduced. Since these data are not used in the original generation of the groups, they can be used as a means of external validation. The question of temporal stability of the groups formed will be addressed by examining the strategic group structure of the industry at intervals over the longest time period for which the data were available (1983-88 for Korea and 1979-1989 for Japan). This approach will also permit studying the evolution of the intra-industry structure as the regulatory and competitive environment has changed. As noted earlier, this has been suggested as an important area for further research (McGee and Thomas, 1986). The statistical procedure most commonly used in strategic group research is cluster analysis, which attempts to partition a data set into groups or clusters of observations which are similar to other observations in their cluster, but different from observations in other clusters. Because there are many possible ways of defining how "similar" observations are, a "maze of concepts, techniques and algorithms" (Aldenderfer and Blashfield, 1984, p. 5) has arisen. Moreover, these methods will generally give different results when applied to the same data set. The selection of a technique must therefore be approached with caution. Two general criteria may be used to assist in the selection of an appropriate technique. These are: (1) how well the characteristics of the method chosen deal with the characteristics of the data set (e.g., presence of outliers, etc.) and suit the desired purpose, and (2) the validity of the resulting groups, particularly as measured by ability to recover clusters in data with a known group structure, and by external validation (i.e., discovery of differences across groups in variables not used to 87 generate the clusters) (Aldenderfer and Blashfield, 1984, pp. 59, 66).86 The cluster analysis method used here is F A S T C L U S (see SAS, 1985, pp. 45-69 and 377-401). F A S T C L U S is a non-hierarchical technique which generates disjoint clusters, i.e., places each observation into one and only one cluster.87 The F A S T C L U S algorithm relies on what is known as "nearest centroid sorting" and proceeds as follows: " A set of points called cluster seeds is selected as a first guess of the means of the clusters. Each observation is assigned to the nearest seed to form temporary clusters. The seeds are then replaced by the means of the temporary clusters and the process is repeated until no further changes occur in the clusters" (SAS, 1985, p. 378). "Nearness" is based on the concept of Euclidean distance, defined as: V k = i where d,j = the Euclidean distance between observations i and j, and Xi,, = the value of the kth variable for the ith observation (Aldenderfer and Blashfield, 1984, p. 25). According to Harrigan (1985), Euclidean distance-based procedures are preferable because they tend to generate "more interpretable clusters" (p. 60). The F A S T C L U S algorithm is stated by its authors to have the following characteristics: (i) a tendency to form groups of equal size, (ii) sensitivity to outliers, and 86. See Harrigan (1985) for an extended discussion of methodological issues involved in the use of cluster analysis in strategic groups research. 87. Harrigan (1985) recommends the use of techniques which produce non-overlapping groups because "additional interpretation of competitive dynamics is possible" (p. 60). 88 (iii) possible sensitivity to ordering of data in small samples (n < 100). Examination of the results of F A S T C L U S on the data sets in use here revealed that there was no tendency for groups of equal size to be formed.88 In fact, the largest group formed for any given year was from seven to 16 times as large as the smallest. The results also did not appear to be overly sensitive to ordering, as various orderings resulted in over 90% of banks being classified similarly.89 A tendency to locate clusters around outliers is actually a benefit for the purposes for which cluster analysis is used here. The purpose of the technique in this context is to identify similarities among groups of banks which may be too complex to be perceived by simple inspection of the data. Groups of banks which are distinctly different are of particular interest as they may have discovered (or been blessed with capabilities enabling them to pursue) particularly successful strategies. Alternatively, they may suffer from disadvantages which restrict them to unsuccessful strategies. Moreover, the selection of variables (i.e., key balance sheet ratios) for use in forming the clusters was made to ensure that if a group of banks was formed into a cluster by virtue of being very high or low (i.e., "outliers") on a variable, that this would in fact represent a meaningful strategic choice or outcome for those banks (i.e., groups would not be formed because banks were outliers on unimportant variables, but only on the basis of their values of key strategic variables).90 Finally, the number of clusters chosen for analysis was relatively 88. Amel and Rhoades (1988) similarly found no such tendency with their data. 89. To avoid potential bias, the ordering used during the analysis was alphabetical by abbreviated bank names which had been assigned earlier. This gave a seemingly random ordering by size, nationality, etc. 90. The variables were also standardized to a mean of zero and standard deviation of one to minimize distortions. 89 large to ensure that clusters were not formed around outliers at the expense of clusters of less individualistic banks. F A S T C L U S has the advantage that it will find clusters up to a specified maximum number without simply aggregating clusters found when larger maxima are specified. It is also very fast and inexpensive to run, which allows extensive sensitivity analysis to be performed, and has been used successfully in studies of strategic groups in U.S. domestic banking (Amel and Rhoades, 1988). 3.5, Data 3.5.1 The Samples The samples used in the first two parts of this study are subsets of one "master sample." The master sample consists of all the banks that were in The Banker's Top 500 listing every year from 1979-1986. The rationale for this sample is that The Banker's listing gives the world's 500 largest banks as ranked by assets. Over the course of the years 1979-1986 (the period for which data on foreign bank operating results in Japan are available) 729 banks were in this listing for at least one year. However, since many of these banks entered the bottom of the listing only briefly (often due to exchange rate fluctuations), they cannot really be considered "major" banks whose resources would allow them to undertake significant international branching. A total of 359 banks were in the Top 500 for the entire period 1979-1986. These banks include almost all the banks in the world with any substantial number of overseas branches and represent some 53 countries.91 91. Algeria, Argentina, Australia, Austria, Bahrain, -Belgium, Brazil, Canada, Chile, China (People's Republic of), Denmark, Egypt, Finland, France, Germany, Greece, Hong Kong, India, Indonesia, Iran, Iraq, Ireland, Israel, Italy, Japan, Jordan, Korea, Kuwait, Libya, Luxembourg, Malaysia, Mexico, Netherlands, New Zealand, Nigeria, Norway, Pakistan, Portugal, Saudi Arabia, Singapore, South Africa, Spain, Sweden, 90 The 370 banks which were excluded from the master sample because they were not in the top 500 for all eight years can be divided into three groups: those that were in the top 500 in 1979, but later dropped out (159), those that were not in in 1979, but later were included (141), and those which were not in in either 1979 or 1986, but were in for one or more years in between (70). The U.S. had the most banks in each of the three omitted groups (50, 34 and 22 respectively), largely due to mergers and acquisitions among regional banks which caused some banks to disappear and others to grow very rapidly. West Germany had the most banks which dropped out in later years (11), while Japan had the most which entered the top 500 only in the later years (22). The rise of these Japanese banks appears to have been principally a result of the appreciation of the yen. No other country had more than eight banks in any omitted group, and most had three or fewer. Altogether, 37 countries had banks in the first omitted group, 38 had banks in the second group, and 22 had banks in the third group. Given the relatively even distribution of omitted banks across countries, this sample selection process should not have introduced any serious biases. There may, however, be a slight tendency to underestimate the importance of size and level of geographical diversification, since the excluded banks were on average smaller and less international than the included ones.92 The sample used for the timing model was derived by taking the 359 banks in the master sample and obtaining the necessary bank-level data for as many as possible of them from the Banker's Almanac. This gave a sample of 251 banks from 42 countries. Switzerland, Syria, Taiwan, Thailand, Turkey, United Arab Emirates, United Kingdom, United States (including Puerto Rico), and Yugoslavia. 92. This selection process ensures that the size variable does not simply capture a "threshold" effect, since the included banks are large enough to undertake overseas activities. 91 Of the 108 banks eliminated in this first step, 39 were Japanese. The remainder were drawn from 34 other countries, most of which had two or fewer banks eliminated, and none of which had more than six. The number of Japanese banks eliminated was relatively high because of the large number of small regional institutions which were forbidden to engage directly in international activities (the Banker's Almanac lists only those banks with which an international banker is likely to come into contact with). With this one exception (which, in fact, contributes to the validity of the sample), the distribution of omitted banks is once again quite even across countries and therefore should not induce any serious biases. After omitting the 21 Japanese banks from the Japanese sample and the one Korean bank from the Korean sample, allowing for three banks with missing data, and eliminating banks which were already established at the beginning of the study period, the final samples consisted of 201-215 banks for Japan and 246 for Korea. The model of choice of organizational form uses a sample comprised of all the non-host country banks in the master sample that were eligible to open branches in the host country by virtue of reciprocity. It was assumed that banks were eligible if their home countries had at least one Japanese bank branch or commercial banking subsidiary, or if at least one bank from their home country had opened a branch in the host country. There were 297 non-Japanese banks in the master sample, 61 of which were eliminated due to a lack of reciprocity. This left a sample of 204 from 20 countries after 32 more banks were excluded due to missing data. There were 350 non-Korean banks in the master sample, 127 of which were eliminated due to a lack of reciprocity. This left a Korean sample of 200 from 10 countries after 23 banks were excluded due to missing data. 92 The "samples" used in the analysis of post-entry performance consist of all the foreign banks which had branches in the host country at the fiscal year end of the year in question.93 Thus, in fact these are not samples, but the entire populations of foreign banks in these countries in the years studied. 3.5.2 The Variables Table 3.5.1(a) lists the independent variables used in the models of timing and form of entry as proxies for the forces leading to the multinationalization of banks discussed in Chapter Two. The variable ASSETS (assets less contra items such as guarantees and acceptances) was selected as the best overall measure of a bank's size. It is readily available for almost all banks in almost all years and is not as strongly influenced by the specific focus of a bank's activities as narrower measures such as deposits, loans, or the number of employees. Ideally one might prefer a measure of geographical diversification which included the relative weight of a bank's business in the countries in which it operates. Such data are not available, however, and hence C O U N T R I E S , the number of countries where the bank has a branch, representative office, or commercial banking subsidiary or affiliate, was selected. Even this variable was not available directly and required a very labour-intensive process of looking up and counting all the overseas offices of every bank in the sample. 93. In 1986 one bank (Marine Midland) was removed from the Japanese analysis because it was just about to close down and therefore had a highly unusual balance sheet (mostly zeros). 93 Two measures of a bank's technological sophistication were used in each model. In Model II, a bank's average market share in foreign exchange trading and lead management of syndicated loans and Eurobond issuance, normalized to adjust for its size, was used as a bank-specific measure (EXPERTISE). The percentage of the home country labour force employed in the financial sector was used as an indicator of home country-specific technology (FINPCT). 9 4 In Model I, slightly different variables had to be used due to data availability. The bank-specific variable was E U R O B O N D S , the amount of Eurobonds lead managed from 1963-67 normalized for the bank's size, as data on foreign exchange and syndicated loans were not available. C O M M P C T , the percentage of the home labour force employed in commerce (including finance) was also substituted for FINPCT as the financial sector was not reported separately in 1966. The presence of customers' subsidiaries and potentially internalizable transactions was proxied by the stock of foreign direct investment by a bank's home country in the host (FDI) and by the home country's imports from the host in Model II (IMPORTS). While variables related specifically to a bank's customers, rather than to companies from its home country in general, would have been preferable, banks do not and probably will never release such information. Imports are a particularly good proxy for transactions which can be recaptured through the establishment of a branch since they involve flows of instruments such as letters of credit which can be drawn back to a bank's overseas 94. In general, as a country develops, its financial sector grows as it becomes more sophisticated. Thus developed countries such as the U.S., Canada, the U.K. , and Switzerland have relatively high percentages (8-13%), while L D C s such as India or Indonesia have very low percentages (<. 1%). This contrasts with the agricultural sector, which tends to shrink in terms of employment as it becomes more sophisticated. 94 branch through simple changes in the wording of the payment instructions. In Model I data availability constraints required that these two variables be lumped together and trade turnover (exports plus imports) was used as an overall proxy for both a captive transactions base and the presence of home country subsidiaries.95 The capitalization of a bank is represented by C A P R A T I O , the capital : assets ratio. There are, of course, some problems with cross-national differences in capital adequacy requirements96 associated with this variable, but it is the only indicator which is available for a large number of banks. The measure of distance selected was the air distance from a bank's headquarters to Tokyo or Seoul in nautical miles (AIRDIST). No other proxy for monitoring costs was available for the number of cities in which the banks used here were headquartered. In Model II relative operating costs were measured by the rent in U.S. dollars on a four-room luxury apartment such as banks usually provide to expatriate staff. Since rents on such accommodation seem closely related to the rents on the prime office space used by banks and since expatriate expenses themselves weigh heavily in the cost structures of foreign branches, it seems more reasonable to use them as indicators of relative operating costs than consumer-oriented overall price indices used to compare the cost of living in major world centres (see the UBS publication listed in Table 3-1 for example). Rent data for 1966 were not available and hence this variable had to be omitted from Model I. 95. Subsidiaries generally buy a substantial proportion of the components, etc. which they require from their parent companies. These purchases will be reflected in the home country export figures. 96. The data are from the period before the Bank for International Settlements (BIS) international capital adequacy requirements were established. 95 Finally, the presence of reciprocity in Model I is indicated by O P E N , a dummy variable (time dependent covariate) which takes the value of zero until reciprocity is established, and one thereafter (see Section 3.2 for further details). The variables used in the cluster analysis are defined in Table 3-1. Unlike Amel and Rhoades' (1988) analysis of strategic groups of banks in several U.S. cities, this analysis does not use all available balance sheet ratios. Many of the ratios are very small (or even zero) for almost all banks, and thus if they were used clusters might be formed on the basis of trivial variables. The five variables listed in Table 3-1 account for about 70% of the combined balance sheets of the foreign banks in Japan and about 90% of the combined balance sheets of those in Korea. Each variable is also an important strategic dimension. D E P , deposits as a fraction of total assets, represents the bank's ability to penetrate the most difficult, yet cheapest, source of funding in both host countries. SEC, securities holdings as a fraction of total assets, is an indicator of the bank's participation in securities markets as opposed to lending. L O A N , the fraction of total assets made up of loans and discounts, measures the bank's reliance on traditional lending activity, while H O , net funding from head office as a fraction of total assets, represents the degree to which the bank relies on internal funds (often borrowed in international markets), rather than raising funds locally. Finally, G T E E , customers' liability under guarantees and acceptances as a fraction of total assets, measures the bank's reliance on off-balance sheet business such as trade-related guarantees or those issued as backup for credits granted to industrial borrowers by other financial institutions. 96 3.6 Foreign Banks and the Japanese Banking Market The presence of foreign bank branches in Japan dates back to 1870, when two British banks (one now defunct) began operations. A third British bank opened a branch in 1895, followed by two each from the Netherlands, the U.S., and France, and one each from Germany and the USSR, so that by 1929 10 foreign banks operated 23 branches in Japan. Except for American Express, which concentrated on the tourist trade, their business was primarily financing foreign trade, particularly with their home countries. This orientation was reflected in the fact that all had branches in at least one of the port cities of Kobe, Yokohama, Nagasaki and Nagoya, while only half operated in Tokyo (Bratter, 1931). World War II, of course, interrupted foreign bank operations, but eleven banks reopened in 1949-50. Once the Occupation ended, however, the new Japanese government imposed a de facto ban on further foreign bank entry, allowing in only a few small Asian banks until the late 1960s. By that time Japanese banks were beginning to expand overseas. To ensure them unimpeded access to overseas markets, as well as to promote the continued inflow of foreign capital, the Japanese government changed its policy, allowing Morgan Guaranty to open a branch in 1969. This opened a floodgate and over 40 others followed in the next decade. (See Table 3-2 and Figure 3-1 for a chronology of the entry of foreign banks into Japan.) The Japanese financial sector has been and still is a relatively segmented one, with a large number of specialized institutions established to channel funds to specific sectors (see Table 3-2 and Figure 3-2). The most direct competitors of the foreign banks have been the city banks, which are headquartered in the major cities and have nation-wide, but limited, networks of branches, the Bank of Tokyo, a specialized foreign exchange 97 bank, and to a much lesser extent the long-term credit banks and regional banks. For the most part, however, foreign banks competed largely among themselves, as they too were accorded a special role in line with the compartmentalized financial system of Japan. In terms of the primary activities of foreign banks in Japan the post-war years can be broken down into roughly four periods. From 1950 to 1955, foreign banks had a virtual monopoly on trade finance and foreign currency transactions, but were prohibited from engaging in domestic business. From 1955 on, foreign banks were allowed to extend limited amounts of yen loans, often funded by "swaps" of foreign currency with the Bank of Japan, since their ability to raise retail deposits was severely constrained by branching restrictions and "voluntary" agreements (Pauly, 1987, pp. 18-19). Their most rapidly growing business, however, was making medium-term foreign currency loans, usually referred to as "impact" loans. The first oil crisis began the third phase of foreign bank operations as the ensuing balance of payments problems led the Euromarkets to charge a "Japan premium," effectively raising the funding cost for Japanese banks seeking to raise dollars offshore for onlending in Japan. As a result, the Ministry of Finance "advised" domestic banks to pull out of impact lending, thereby creating a lucrative de  facto monopoly on such business for the foreign banks which lasted until 1979. At that time, Japanese banks were once again allowed to enter the impact loan market as part of the dismantling of foreign exchange controls which culminated in the Foreign Exchange and Foreign Trade Control Law of 1980. They took over 50% of this market by 1981 (Pauly, 1987, p. 38). Since that time there has been a very slow tendency to 98 move towards national treatment97 of foreign banks. In practice, however, this movement has tended to be quick to remove privileges and slow to remove restrictions which would allow the foreign banks to compete with the major Japanese banking institutions. Given the close bank-business ties which have characterized the Japanese economic scene, the now massive size of the Japanese banks (see Table 3-4) and the declining importance of bank lending as cash-rich corporations increasingly earn their profits from financial speculation (zaiteku) rather than production, foreign banks face formidable obstacles in penetrating the market in any case. The effects of these changes in the operating environment can be seen in the growth and profitability of the foreign bank sector. Although at the end of 1962 the funds raised and loans made by foreign banks equalled only about .6% and .7% respectively of those made by the city banks alone (Bank of Japan, 1964, p. 87), by 1976 their impact loan monopoly had pushed their share of loans up to 3.37% (see Table 3-4). This period saw not only rapid growth (see Table 3-6), but also relatively good profitability of about 1% R O A . By the end of the 1970s, however, increased competition for a shrinking pie had cut this to less than .3% (Table 3-6), and it has since decreased even further to .2% or less in recent years (Table 3-7). As can be seen in Table 3-8, this latter pre-tax figure is roughly similar to the after-tax returns of the large domestic city banks and is quite low by international standards. In addition to low profitability there are three other rather noteworthy features of the foreign bank sector in Japan. First, as Table 3-9 shows, their market share has once again declined to about 1% of loans. Second, their even lower market share in raising 97. That is, a policy of treating Japanese and foreign institutions alike. 99 funds reflects their continued difficulty in gathering deposits in a market where interest rates are not yet entirely free to be set by market forces and practical difficulties such as the cost and availability of suitable locations constrain the building of branch networks. Finally, since 1987 an increasing fraction of total profits has come from extraordinary items.98 This reflects the intense competition which has driven down ordinary income from operations as the Japanese market matures and Japanese banks become more competitive. (One area where Japanese banks still lag, however, is in international representation, as Table 3-11 shows.) In summary, then, foreign banks in Japan have experienced substantial change in the post-war period, but they have generally remained marginal players, earning their living by exploiting their superior access to international markets and international banking expertise. 3.7 Foreign Banks and the Korean Banking Market Foreign banking in Korea has a long history. The Japanese established the country's first modern bank, the First National Bank, in Pusan, Korea's principal port, in 1878. Although a number of indigenous Korean banks arose in the years that followed, most quickly failed due to a lack of capital and expertise, and Japanese banks came to dominate Korean finances. This domination was strengthened still further when the Japanese annexed Korea and renamed the then two-year old Bank of Korea the Bank of Chosun in 1911 (Nakarmi, 1988). 98. For example, one major American bank reportedly made more in one recent year from selling its manager's bank-supplied home than it did from operations (interview with the author, April 1989). 100 Korea's liberation in 1945 brought the end of Japanese colonial rule, but the immediate post-war years were still a time of severe economic dislocation. Two officials of the Federal Reserve Bank of New York were assigned the task of drafting new legislation to re-establish central and commercial banking in the young republic as part of the government's efforts to stabilize the economy (see Bloomfield and Jensen, 1951). Statutes based on their recommendations were passed in April 1950, but just days after the Bank of Korea was established in June 1950, the Korean War broke out. This delayed implementation of the General Banking Act until 1954. By that year four of the five major Korean commercial banks were in existence: the Choheung (later Chohung) Bank, the Commercial Bank of Korea, and the Korea Savings (later Korea First) Bank, all of which had their roots in the Japanese colonial period, and the newly established Korea Hungop (later Hanil) Bank. The fifth of the five indigenous city banks was originally established as a regional bank in 1959 under the name of the Seoul Bank. It later merged and became the Bank of Seoul and Trust Company (1976) and was renamed the Bank of Seoul in 1985 (Bank of Korea, 1985). In 1961 a military revolution brought Chung-Hee Park to the Presidency. Park began a series of five-year economic plans in which the banks were to play a major role (see, e.g., Kwack and Chung, 1986). His government took over majority ownership of the banking system in 1962, amended the Bank of Korea Act to place the central bank firmly under government control, and founded a number of specialized banks to support agriculture, the fisheries, small and medium-sized businesses, etc. Regional (local) banks were also established. In contrast to the major commercial banks, which had nationwide networks of branches, the 10 regional banks were confined to their home provinces 101 except for a single branch in Seoul (Bank of Korea, 1985)." Internationally, 1967 proved to be a key year. The foreign operations of the Bank of Korea were split off into the newly established Korea Exchange Bank, and the first foreign banks, Chase Manhattan, the Bank of Tokyo and Citibank, were allowed to establish branches. Other foreign banks followed, slowly at first, but eventually at a very rapid rate, until by the late 1980s there were over 50 foreign bank branches operating in Seoul and Pusan (see Table 3-13 and Figure 3-3). The early 1980s saw two other major changes in the banking scene. Four of the major commercial banks were de-nationalized in 1981-83.100 At the same time, two new joint venture commercial banks were established. The Shinhan Bank was founded by Koreans resident in Japan, while the Koram Bank united the Bank of America and several major Korean companies (Bank of Korea, 1985). Thus by the mid-1980s Korea's present institutional framework was more or less complete. Figure 3-4 provides a breakdown of the financial institutions in Korea as of the end of 1985,101 while Tables 3-14 and 3-15 provide some indication of the relative importance of the different types 99. This restriction was later relaxed to the extent that regional banks can open more branches in Seoul (but not elsewhere) if they channel the funds raised back to their provinces (Nakarmi, 1988). 100. The Commercial Bank of Korea had been returned to private ownership in 1972. 101. Non-banking institutions are included for completeness; however, the deposit money banks are the key focus here, as the other institutions are not, by and large, direct competitors of the foreign banks in Korea. 102 of institutions within the Deposit Money Bank (DMB) sector.102 Foreign banks in Korea have several striking characteristics including: (a) heavy reliance on advances from their head offices for funding, (b) use of Bank of Korea swap facilities to gain access to local currency (won) funding, (c) very high dependence on and market share in foreign currency lending, and (d) relatively high (though controversial) levels of profitability. To a large extent these characteristics have been determined by regulatory limits on the extent to which they have been allowed to compete directly with Korean banks. While concern about national sovereignty frequently leads host countries to impose such limitations, the Korean government has had several additional reasons to shield its banks from foreign competition. Throughout Korea's industrialization local banks were forced to make so-called "policy loans" to priority sectors, while foreign banks did not have such burdens imposed on them. Foreigners therefore had a substantially greater advantage than their admitted technological superiority would have given them. Part of the legacy of the "policy loan" period for Korean banks has been a crippling burden of non-performing assets resulting from loans to now declining industries. These loans may have made up as much as 30% of Korean banks' loan portfolios at one time and probably still make up at least 8%. A further burden results from the fact that 102. Some minor discrepancies will be noted in the data tables in this section, despite the fact almost all the authors who compiled them relied on Bank of Korea data. These discrepancies appear in almost every source of Korean data, including official publications, and no indication is ever provided which might assist in reconciling the numbers. Fortunately, the intent here is to point out general features of the Korean banking market, and the differences are not large enough to affect the overall conclusions. 103 despite privatization "bank managers have never been free in making decisions... [because] the government uses its influence through the chief executive officers of the commercial banks who are nominated by the government and rubber-stamped by the shareholders of the bank" (Nakarmi, 1988, p. 34). Given the weak position of Korean banks, their small size (see Table 3-16), and their lack of international experience (see Table 3-17), "only when the government feels that the domestic banks are able to compete will the foreign banks in Korea be allowed full access to the Korean market" (Kim, 1989, p. 10). One of the restrictions which has led foreign banks to rely heavily on advances from their head offices and branches for their funding (see Table 3-17) has been a limitation on branching. Foreign banks were limited to one branch in Seoul (the capital) and one in Pusan (the main port) until 1988, and hence had little access to retail deposits.103 Raising won from other sources has been severely constrained by a poorly developed interbank market, tight restrictions on the issuance of debentures and CDs, and strict interest rate controls (Kim, 1989, p. 4). Given the constraints on foreign banks' access to local currency funding through normal channels, the Korean government established an alternative procedure for them to raise won known as the swap facility. Swap transactions with the Bank of Korea are similar to repurchase agreements with a guaranteed profit margin. They allow a foreign bank to exchange foreign currency for won funds at guaranteed exchange rates (Kim, 1989). Swap quotas and the profit margins on them have been cut several times in recent years as Korea's need for foreign currency has fallen and as the government has 103. See Newsreview (Korea), October 21, 1989, pp. 12-13 regarding the latest liberalization of foreign bank branching. 104 moved slowly towards national treatment of foreign banks. According to the General Banking Act, commercial banks in Korea, including foreign banks, are allowed to engage in short and long-term financing (up to 15 years), to "invest in securities and handle guarantees and acceptances, remittances and collections, foreign exchange business, and receipts and disbursements of treasury funds as treasury agencies of the Bank of Korea" (Nakarmi, 1988, p. 34).104 In practice, however, shortages of won funding and government encouragement (through tax exemptions, etc.) to help feed the voracious appetite Korea had for foreign currency until 1985 have led foreign banks to concentrate on lending, and especially foreign currency lending, to a greater degree than Korean banks. Table 3-19 shows the high market share foreign banks have had in foreign currency lending in Korea relative to their success in other lines of business. Since Korea began recording current account surpluses in 1986, however, they have lost market share in this segment to domestic banks. The final distinguishing feature of foreign banks in Korea that will be discussed here is their relatively high profitability compared to both international benchmarks (see Table 3-8) and the Korean banks (see Tables 3-20 and 3-21). Foreign banks are in fact frequently vilified in the Korean press as profiteers, a charge they deny, claiming reported profits are overstated because they do not include the salaries of expatriates paid by head offices, translation losses on and the opportunity costs of invested capital, reserves and earned surplus, and head office expense allocations. Even after such adjustments, however, foreign bank profits appear substantially higher than those of 104. See Nakarmi (1988, p. 37) for a list of prohibited businesses. 105 domestic banks (Business Korea. June 1984, p. 37). Part of the higher return may have been due to the higher risks associated with cross-border lending to Korea when its debt burden was heavy, but in general foreign branches have been quite happy with their profitability until recently,105 although some of the larger institutions have been impatient with their inability to press their advantages while Korean banks are still weak. In summary, foreign banks have traditionally had a narrow but profitable role in Korea, providing valuable linkages with international capital markets and bringing in more sophisticated banking skills than domestic institutions have been able to provide. At the same time, their position has been a vulnerable one, as they exist only with the sufferance of a host government determined to ensure future banking markets are dominated by local institutions. 3.8 Hypotheses To make predictions about the signs of coefficients in a statistical model, one needs to know more than the theoretical model underlying the phenomenon being modelled: one must also consider the structure of the data. For example, if one of several factors in an experiment is held almost constant, one should not be surprised if the coefficient on it does not turn out to be significant. This section reviews each model briefly, considers the special circumstances of the host countries, and ends with a summary of the predicted signs for Models I and II. Large, geographically diversified banks should have had strong incentives to enter both the Japanese and Korean markets to facilitate the matching of customer needs since these markets have had relatively fewer international financial linkages than, for 105. Interviews by the author, April 1989. 106 example, the U.S. or U.K. (see, e.g., Tables 3-11 and 3-17). Japanese and Korean banks also had an incentive to internationalize (and did so to some extent), but were held back by government regulations restricting the pace of overseas expansion. They were also at a disadvantage in providing such linkages since a foreign bank with an existing network could link Japanese (Korean) customers with many overseas markets simply by opening in Japan (Korea), while a Japanese (Korean) bank might have had to open many overseas branches to achieve the same capability. Foreign banks could also benefit from the expansion of Japanese and Korean business overseas which has proceeded rapidly in recent years (see Tables 3-22 and 3-23). Thus, in both countries ASSETS (asset size) and C O U N T R I E S (the number of countries in which a bank has branches, subsidiaries, representative offices or affiliates) should be positively related to entry. In both Models I and II, the signs of the coefficients on these variables should therefore be positive. In both Japan and Korea, foreign banks were allowed in at least in part to gain access to their superior skills, particularly their international expertise. Thus, coefficients on both general banking sophistication (measured by FINPCT, a proxy for the level of development of the financial sector in the home country) and international capabilities in areas such as syndicated loans, foreign exchange and management of Eurobond issues (represented here by the variables E U R O B O N D S and E X P E R T I S E ) should be positively related to entry. This tendency should be particularly strong in Korea, whose banks even today are relatively small, weak and unsophisticated. Neither Japan nor Korea have large customer groups with which foreign banks would have an information processing advantage, as both foreign direct investment levels and immigration were severely restricted throughout the period under study. (Tables 3-107 23 to 3-27 provide data on foreign direct investment in the two countries.) While it is possible that the Korean minority in Japan might offer some advantage to Korean banks seeking to operate there, in general few such opportunities are likely to exist. Foreign banks' ability to recapture transactions related to their home country's imports from Japan has also been severely constrained because of the unusually large share of Japanese exports handled by the sogo shosha (general trading companies).106 Given these characteristics of the two host markets, it seems unlikely that FDI, I M P O R T S or T R A D E (proxies for the existence of customers' subsidiaries and captive transactions) will show enough variation to be significant. The strength of the relationship of capitalization to entry should depend on two related factors. The larger a market's need for funds, the greater the importance of a strong capital base to be able to raise the large volumes of funds required. Moreover, the value of a heavily capitalized foreign bank's "certification" should be greater to markets that have a large need for external funds. Both Japan and Korea have undergone periods of heavy external borrowing. In Japan this period was drawing to a close by the late '70s, but it continued until about 1985 in Korea, when that country's foreign debt peaked at about U.S. $50 billion (see Table 3-28). Thus, capitalization should be positively related to the dependent variables in both Models I and II. Given the vast distances which separate Tokyo and Seoul from many potential host countries, AIRDIST, the variable reflecting the effect of distance (including time zone 106. Home country exports seldom result in much opportunity in foreign markets unless the host country is very short of foreign exchange. This is because obtaining the letter of credit business from foreign importers requires the establishment of lines of credit: This process is relatively involved compared to what is needed to get the business of foreign exporters. 108 differences) on monitoring costs, should have a negative coefficient. R E N T , the proxy for relative operating costs, should, on the other hand, have a positive coefficient because the higher the home country's cost level, the more likely a bank is to want to produce its services in the host country rather than at home. In summary, this thesis posits that: Probability of = / (ASSETS, COUNTRIES, CAPRATIO, COMMPCT, EUROBONDS, Entry (Model I) + + ++ ++ ++ + + DISTANCE, TRADE, OPEN) 00 + + Probability of = / (ASSETS, COUNTRIES, CAPRATIO, FINPCT, EXPERTISE, having a branch ++ ++ ++ ++ + + (rep office) presence DISTANCE, RENT, FDI, + + 00 IMPORTS) 00 where the first and second signs below the variable names indicate the expected signs of the coefficients in models for Japan and Korea respectively'07 and where P R O B A B I L I T Y O F E N T R Y = The instantaneous probability that a bank will enter a market given (Model I) that it has not yet entered,108 or more formally, h(t) = Mm P (t <T < t + *t | T >t) A M ) ~ It 107. Zeros indicate that the expected coefficient is zero (no effect). Positive signs indicate that a high value of the variable is associated with earlier entry, while a negative sign indicates that it is associated with later entry. Thus it is predicted that banks with large asset totals will enter earlier than smaller banks, while banks a great distance from the host market will enter later than nearby ones. Data availability accounts for the small difference in the proxies used in the two models, as explained above. 108. Banks with a high instantaneous probability of entry would be expected to enter early, since it becomes progressively less likely that they will not have entered as time goes on. In essence, this is equivalent to timing (speed) of entry. 109 P R O B A B I L I T Y O F P R E S E N C E = Probability that bank i will have a branch (representative office) at time t, or more formally (Model II) P (Xj, = 1), where xit is a dummy variable which equals one if bank i has a branch (representative office) at time t, and zero otherwise. 110 Chapter Four R E S U L T S 4.1 Model I (Survival Timel Analysis 4.1.0 Introduction Model I applies the Cox proportional hazards survival time model to identify factors associated with early entry. The premise underlying this analysis is that banks with strong competitive advantages will be attracted to a market sooner than their less favoured rivals. By examining the entry decisions of a large number of potential entrants it becomes possible to take advantage of the greater variation in independent variables in such a large sample to perform a more powerful test of the importance of various characteristics than would be possible by examining only actual entrants, as previous studies have done. Table 4-1 presents the results for Model I. Chi-squared likelihood ratio tests of the significance of the overall models indicate that all four variants (branch and representative office for Japan and Korea) are highly significant (p < .0001) (see Schoenfeld, 1980). As noted in Chapter Three, sensitivity analysis was conducted to determine whether the findings were robust with regard to the exact period chosen. Neither moving the beginning of the period back one year (to January 1, 1966) or forward three years (to January 1, 1970) nor bringing the endpoint up seven years (to 1980 instead of 1987) had any major effect on the results. The analysis was also run using 1983 values of the variables instead of 1966 values. The results were essentially Ill the same.1 109 Although the results are not reported here, the branch entry analysis discussed below was also repeated for subsamples including: While the smaller sample sizes resulted in slightly fewer significant variables in these results, they were otherwise quite similar to those in Table 4-1. 4.1.1 Japan As predicted, in the Japanese results size (ASSETS) was very strongly associated with entry, which supports the hypothesis that their size gives large banks a competitive advantage due to their greater ability to match customers with offsetting needs, the lower risk they face in transforming assets, and their greater ability to absorb start-up costs and The extent of a bank's geographical diversification (COUNTRIES) was significantly related to early entry by representative offices, but not by branches. This initially surprising finding may be the result of a "bandwagon effect." As discussed in Section 109. Because the exact day when a foreign bank opened its rep office in Japan could not be identified in a few cases, the ties were broken using random number tables. As a check, ties were also broken by assuming rep office entry occurred in the same order as branch entry. The latter method gave results which were almost identical with the results of random tie-breaking reported here. 110. The author conducted a series of iterviews of foreign bank branch managers and local regulatory officials in April, 1989. Approximately two dozen individuals were interviewed in Tokyo and a further dozen in Seoul. The questions asked centred on the reasons for establishing the branch, the nature of its current activities, and the impact of deregulation. These interviews tended to indicate that diversification is probably the most significant reason. Several branch managers indicated that they frequently changed their business emphasis to cope with changing market conditions. Large banks should be better able to find a critical mass of customers in a variety of different lines of business. . • • i) ") iii) U.S. banks L D C banks, and banks from developed countries other than the U.S. risks. 10 112 2.2.2.3, it can be rational for firms to imitate the investments of others when the latter are known to be better informed (Gilbert and Lieberman, 1987). If the most internationally-oriented banks "tested the waters" by establishing representative offices and then found branches worthwhile, less experienced banks may have concluded that with their general international background and some direct experience with the market, the banks opening branches must have known what they were doing and hence decided to follow suit. The coefficient on the capitalization ratio (CAPRATIO) was significant for both branches and representative offices, which supports the notion that the value to borrowers of certification by such banks was important to their eventual access to overseas credit markets, and also that such banks were more attractive to depositors. (Given the severe restrictions on deposit-taking by foreign banks during most of this period, however, the former explanation is likely more important than the latter.) Surprisingly, while the country-specific technology variable ( C O M M P C T ) was significant at the .05 level for branches and at the .10 level for representative offices (t = 1.90), the bank-specific technology variable ( E U R O B O N D S ) was not. One possible explanation for this result is that the variable E U R O B O N D S may be too narrow, since it captures only expertise in the Eurobond market, which was then a relatively new line of business. O n the other hand, since most entry came during the impact loan era (pre-1980), special expertise may have been superfluous due to regulatory constraints which almost guaranteed profits for all. D I S T A N C E was negatively associated with time of entry in both the representative office and branch models. This relationship, which was significant at the .01 level for branches and the .10 level for representative offices, provides support for the existence 113 of costs of monitoring borrowers at a distance. It is particularly interesting that this relationship is stronger for branches than for representative offices, since branches deal with smaller clients than representative offices, because the latter can only book loans abroad and hence deal with firms large enough to pursue financing from offshore sources. Since smaller, more domestically-oriented clients are those who need the most monitoring, it seems logical that branches would be the most severely affected by monitoring costs. The coefficient on T R A D E , the proxy for customer dealings with the host country, was significant at the .05 level for representative offices and at the .10 level for branches. Although a zero coefficient had been predicted, in both cases the sign was negative. Since it seems unlikely that trade would in itself discourage entry, this may be a reflection of the strong position of European institutions in international banking, which encouraged them to enter more quickly than their counterparts from the U.S., which was (and remains) the main trading partner of both host countries. The relative strength of the Europeans may reflect the greater concentration on domestic business of U.S. banks, apart from the few top-ranked money-centre institutions. The coefficient on the time-dependent covariate representing regulatory openness was significant and positive. This result is consistent with a view of host country regulation as being guided by a realistic appraisal of overall national costs and benefits. Japan was a highly desirable borrower throughout the period under study here and had (relatively) many large banks which could take advantage of opportunities in other countries. Thus the national interest of Japan would argue for strict reciprocity to ensure access to overseas opportunities for its banks, and this was the result obtained here. 114 4.1.2 Korea As predicted, both bank size and level of geographic diversification were significantly positively related to early entry for both representative offices and branches. Thus, as was the case with Japan, the Korean results support the importance of diversification, experience, reputation and financial staying power. Although the coefficient on the capitalization ratio was significant for both branches and representative offices in Japan, it was not in Korea. This pattern may reflect in part the perceived riskiness of the Korean market when it first opened up to foreign banks. Although now a widely-envied NIC, Korea was at that time still a very poor Third World country. If capitalization reflects a bank's degree of risk aversion (which, in essence, is why the market values a heavily capitalized bank's "certification" more), it may be that the heavily capitalized banks Korea wanted to attract were not prepared to accept the risks of greatly increased Korean exposure at that time. The prediction of a positive effect assumed that the demand for a conservatively financed bank's "certification" would be sufficient to induce entry; however, this may be a case of the supply of such certification failing to meet the demand.111 Alternatively, Korea's banks may have been sufficiently weak that any major world bank enjoyed such an advantage over local institutions that this variable had little discriminatory power. As in Japan, the relationship between home country banking technology and early entry was significant (at the .01 level in both the branch and representative office 111. A factor which strengthens this argument is the small number of representative offices in Korea. Since these are often "branches in waiting," their small number would seem to indicate a relative lack of interest in increased Korean lending. Moreover, as Korea's debt moved towards its peak, an increasing percentage of new borrowing was intermediated by a relatively few banks, again indicating reluctance by many lenders to increase lending to Korea. 115 models), but the bank-specific technology variable was not significant in either model. The explanation for this finding is likely to be similar to that given for Japan. The importance of distance and its effect on costs of monitoring is once again confirmed by the results for Korea, with the coefficients on this variable being significant at the .01 level for both branches and representative offices. Although the coefficient on the T R A D E variable was not significant in either Korean model, its sign was negative in both, which suggests the Japanese result may not have been generated purely by chance. Finally, the time-dependent covariate O P E N , representing the existence of reciprocity, was not significant at the .05 level, though it was at the .10 level. This suggests that reciprocity was applied rather loosely, if at all, by the Korean authorities. Once again, this finding indicates an entry policy which takes full account of the relative costs and benefits to the host nation. By comparison with Japan, Korea was a very highly indebted country with no truly world-class banks. Thus while Japan could afford a policy which denied entry unless its banks enjoyed similar opportunities in a bank's home country, Korea's policy reflected a need to retain and improve access to foreign borrowing at almost any cost-particularly when its banks were unlikely to make many inroads overseas anyway. 4.2 Model II (Multinomial Logit) Analysis 4.2.0 Introduction Model II uses multinomial logit analysis to examine simultaneously the factors which differentiate banks that have opened branches in the host country from those that have not established themselves there and the factors which differentiate banks that have opened representative offices in the host country from those that have not. As with 116 Model I, this approach permits the use of a sample which both is larger and has greater variation in the independent variables than the samples of incumbents only which have typically been the subject of earlier studies. The results of the multinomial logit analysis for Japan and Korea are reported in Table 4-2. Both the Japanese and Korean models were highly significant (p < .01) as indicated by the likelihood ratio test statistic (see Maddala, 1983). Their performance in terms of prediction was also high (80.88% correct in Japan and 92.50% in Korea). Table 4-3 also provides average elasticities for both models. These elasticities measure the percentage change in the probability of choosing a given form of representation that results from a one percent change in the independent variable. The values reported are the averages of the elasticities evaluated using the values of the independent variables at each data point. 4.2.1 Japan The Japanese results indicate that the relationship between size (ASSETS) and having a branch in Tokyo is highly significant but size is much less strongly associated with having a representative office (significant only at the .10 level). This may reflect the fact that the largest banks, having the greatest profit incentive to open a branch, have already done so, leaving mostly the slightly smaller banks to make do with the lower cost representative offices. The effect of size (as measured by its average elasticity) is relatively small, however, compared to other variables found to be significant. C O U N T R I E S , the proxy for the extent of geographical diversification, is positively associated with both forms of representation, as predicted. Banks which already have offices in many countries are more likely to open either a branch or a representative 117 office in Japan as well. The average elasticities are of a magnitude similar to the A S S E T S elasticities, i.e., relatively small. The negative sign on the elasticity of the probability of having a representative office results from its being an average. At very high levels of the diversification variable, a bank becomes much more likely to have a branch than a representative office. On average, this outweighs the tendency for banks in the lower range to be more likely to have a branch than nothing as they get bigger. The capitalization ratio is not significant for either branches or representative offices. While this result does not confirm the prediction made in Chapter Three and differs from the Model I result, there is a strong possibility that this is largely a data problem, as the 1966 and 1983 values of this variable showed by far the lowest correlation (.3) of any used here (most of the 1966 to 1983 correlations were above .8). As in the Model I results, the country-level technology variable (FINPCT) was significant while the bank-level variable (EXPERTISE) was not. Once again it appears that foreign banks entered to exploit general banking skills rather than leading edge technology. The country level technology variable appears to have been very influential in the case of branches, as indicated by its average elasticity of over two. Neither of the two proxies for customer dealings with the host country (IMPORTS, FDI) were significant at the .05 level in either the branch or representative office models, although the signs on FDI were negative in both models and the coefficient was significant at the .10 level for branches. This seems to confirm the pattern found in the Model I results, i.e., a negative but weak overall relationship with customer dealings with the host country. Possible explanations of this unusual result are that: (i) Some countries may have a relative advantage in financial services which their banks venture abroad to exploit, while others have an advantage in manufacturing, 118 which leads their corporations to invest abroad; (ii) Multinational corporations from home countries with a large amount of FDI may have outgrown the need for a home country bank's help, resulting in a drying up of opportunities for banks from countries with large investments in the host markets; and/or (iii) The countries with the largest investments in the host markets may have more domestically-oriented banks due to the large size of their home markets, and these banks may find ample room for business expansion at home. The relative operating costs variable (RENT) was not a significant predictor of either form of representation (except perhaps weakly for branches), but the coefficient on D I S T A N C E was highly significant. The negative effect of D I S T A N C E appears to be very strong, particularly on the establishment of branches, since the absolute value of the average elasticity was almost five. Taken together these results seem to support the importance of monitoring as a motivation for banks to move overseas. The insignificance of relative operating costs implies that, at least for the types of services foreign banks provide in these two countries, banks do need to be close to their customers. The strong, negative relationship between distance and presence is also consistent with the continued existence of difficulties in monitoring borrowers at a distance even in today's era of supersonic air travel and nearly instantaneous telecommunications."2 In fact, with the increasingly competitive environment in Japan and the end of the era of implicit government and main bank guarantees of loans made 112. Since the analysis controls for country-level variables, it is unlikely that distance is acting as a proxy for any one country. Moreover, the average distance from the headquarters of both European and American banks is relatively similar. (The Europeans are not necessarily further away, just in a different direction.) 119 by foreign banks, one might argue tha monitoring has actually increased in importance since the end of the impact loan era. In summary, the Japanese results seem to indicate that for the most part the basic forces leading to the establishment of branches and representative offices are very similar. The differences were all slight, such as variables being insignificant in the rep office model but weakly significant (at .10) in the branch model, or weakly significant (at .10) in the rep office model and significant (at .05 or better) in the branch model. The patterns in the magnitudes of the average elasticities also tend to confirm the notion that it is not the nature of the underlying forces that differs, but rather their degree. Banks with branches and those with rep offices appear to have the same characteristics differentiating them from banks without a direct presence, but banks with branches have higher levels of these characteristics. Thus the Japanese results suggest that we need only one theory to account for both forms of overseas expansion.113 4.2.2 Korea Examination of Table 4-2 reveals a striking feature of the Korean results: only one variable (COUNTRIES) in the representative office model had a coefficient which was significant at the .05 level or better, and only two (COUNTRIES and C A P R A T I O ) were significant at the .10 level. However, since there were very few representative offices in the Korean sample (only 15), it would not be wise to read too much into the lack of significance of these coefficients. Only the branch results will therefore be discussed 113. This does not, however, conflict with findings such as those of Heinkel and Levi (1989), who found that in the U.S. branches and representative offices did not appear to compete, since the establishment of both forms could be motivated by the same broad forces, while their detailed activities could involve niches which avoided any direct competition. 120 below. As with Japan, both ASSETS and C O U N T R I E S were significantly positively related to a branch presence in Korea. The size of the effects of these variables as measured by average elasticities appears larger in Korea than in Japan. This may indicate that with its much smaller market, Korea could attract only banks with very high levels of these variables. Contrary to predictions, the coefficient on the capitalization ratio was negative. This may indicate that relatively non-risk averse banks were more likely to enter the Korean market. (Recall that Korea's foreign debt had climbed rapidly and peaked in 1985, about the time of this analysis.) However, since this result is quite different from the findings of the Model I analysis, it may be another manifestation of the data problem alluded to in the previous subsection, i.e., the relative instability of the capitalization ratio over time (in comparison with the high degree of stability of the other variables). As in Japan, the country-level technology variable was significant, but not the bank-level variable. The very large average elasticity on the country-level variable again underlines the importance of a high level of general banking sophistication, even if specific state-of-the-art skills are not required. The coefficients on the proxies for customer dealings with Korea (IMPORTS, FDI) were similar in direction to those for Japan, but the relationships were somewhat stronger. The coefficient on IMPORTS was positive and significant at the .06 level, but not at the .05 level,114 while the coefficient on FDI was negative and significant at the .01 level.1 1 5 The elasticities also indicated that these variables were quite influential. 114. It was positive but not even significant at the .10 level for Japan. 115. It was negative and significant at the .10 level for Japan. 121 The positive sign on IMPORTS in the Korean case may reflect the lack of penetration of Korean banks abroad and the greater role of non-trading company imports into home countries relative to Japan. Both of these factors would increase the potential for a foreign bank to profit from trade finance opportunities in Korea. The negative coefficient on FDI is likely due to relative underrepresentation of banks from the two countries that have the largest investments in Korea. Both Japan and the U.S. have relatively large domestic markets, which allow banks substantial room for domestic expansion before they feel any need to expand abroad. In the case of Japan, it may also reflect the legacy of earlier restrictions on the overseas expansion of Japanese banks. The coefficients on R E N T , the relative operating costs proxy, and D I S T A N C E , the monitoring costs proxy, were insignificant and strongly negative respectively. This is the same pattern as was found in the Japanese results, which lends further support to the notions that for many bank dealings a personal presence is necessary even if expensive, and that banks which must monitor their clients from a distance are less likely to enter a market than those which are nearby. The average elasticity with respect to D I S T A N C E was particularly large, underlining this conclusion. By and large, the Korean (branch) results were quite similar to those for Japan. ASSETS, C O U N T R I E S and FINPCT were positive and significant in both branch models, while D I S T A N C E was negative and significant in both. Neither R E N T nor IMPORTS was significant at the .05 level in either. There were differences, however, in the coefficients on C A P R A T I O , E X P E R T I S E and FDI, all of which were significant in the Korean model but not (at the .05 level, at least) in the Japanese model. These differences are consistent with the observation that there are simply more reasons for a bank to want to be in an IFC such as Japan than there are in Korea. These reasons, 122 many of which were alluded to in Chapter Two, include reputation effects, availability of information, and access to Japan's vast pool of capital. 4.3 Post-Entry Competition 4.3.0 Introduction The analysis of post-entry competition in the two host countries investigates whether the activities of foreign banks are consistent with the theory advanced in Chapter Two. The first step in this process is a cluster analysis to find patterns among the banks, i.e., to identify banks whose activities (as they are reflected in key balance sheet ratios) share broad similarities. Once such patterns are identified, knowledge of overall strengths and weaknesses of the parent banks gleaned from a search of the trade press can then be used to determine whether the local activities of the foreign bank branches are consistent with their parents' competitive advantages and the overall bank strategies based on them. Each of the sections that follow first summarizes the structure of the industry identified by the cluster analysis and then reviews the activities and successes of individual banks in detail. 4.3.1 Japan Figure 4-1 and Tables 4-4 to 4-7 summarize the results of the cluster analysis for Japan. Various maxima from two to six were specified for the number of clusters for each year. Since in two out of four cases only five clusters were found when a maximum of six were allowed, it appears that the number of strategic groups in Japan is not more than about five or six. The six cluster results116 will be discussed here to avoid 116. Five clusters in 1979 and 1986. 123 overlooking potentially important groups by forcing them into a smaller number of clusters. Given that the intent is to identify phenomena worthy of more detailed attention rather than to put forward a particular classification as definitive, a slight tendency to err on the side of finding more rather than fewer groups seems appropriate. To discuss the characteristics of the groups, clusters which had a mean value of ± 1 for any variable will be referred to as being "high" or "low" on that variable. (Recall that all variables were standardized to a mean of zero and a standard deviation of one.) In addition, if two groups are very similar and have no variables with a mean value of ± 1 or more, they will be distinguished by the variables whose mean values differ by one or more between the groups, and the one with the higher (lower) mean on such a variable will be referred to as being "high" ("low") on it. Table 4-8 provides details of the means of the clusters on each variable. In general, most banks fall into one or two large groups with fairly average balance sheets. Where these banks are split into two (1979, 1983) or three (1989) groups, the distinguishing feature between them is their reliance on lending. In 1979, for example, 50 of the 63 banks were in the two "average" groups, with about 60% of these falling into the "high loans" group and the remainder into the "low loans" group. By 1983, two-thirds of those in the high loans group were still in that group, while five (one-sixth) dropped into the low loans group and three split into a group which still had high loans, but also had above-average reliance on deposits. Just under half of the 1979 low loans banks were also so-classified in 1983, with most of the remainder moving up into the higher loans group. Nine out of 11 new entrants over the 1979-83 period moved into the low loans group, while only two were able to penetrate the high loans group. In 1986 there was insufficient variation in loans among the "average" banks to form 124 two groups and one very large group of 46 banks was found. Over 80% of the banks from the 1983 high loans group moved into this "supergroup," along with over one-half of those from the 1983 low loans group. Most of the remaining banks from these two 1983 groups moved into a 1986 group which was slightly lower than average in loans, but much higher in reliance on deposits. In 1989 the "supergroup" of average banks split into three. Over one-half separated into a high loans group, with the remainder splitting almost evenly into a low loans group and a truly "average" group. Apart from these very large groups following "mainstream" strategies, smaller groups of banks have followed strategies distinguished by heavy reliance on deposits, low reliance on head office advances, strong emphasis on guarantee business or high securities holdings.117 Because, as noted in the methodology section, cluster analysis results are not unique, i.e., by applying different clustering algorithms quite different groups can be formed from the same data, it is important to check the validity of the groups found by determining: (a) whether the groups found are stable over time; (b) whether there are performance differences across groups, and if so, to what they appear to be attributable; and (c) whether the groups to which banks belong appear to correspond to what is known about their competitive advantages. 117. In 1987, 1988 and 1989, the only three years for which a breakdown is available, securities held for investment rather than trading accounted for 91%, 95% and 98% of total securities held by foreign banks. 125 A further question of interest is what determines the relative performance of members of the same group. Despite the relatively fine breakdown of the foreign banking sector used here, the stability of the groups is good, ranging from 58% from 1979 to 1983 to 72% from 1983 to 1986.118 Overall an average of 64% of banks which were clustered together in one year were also clustered together in the next year studied (i.e., three to four years later). This level of stability is virtually identical with that found by Amel and Rhoades (1988) in their study of strategic groups among American banks. As can be seen from Figure 4-1, there also appear to be rather substantial differences in profitability across groups, with one group having aggregate profitability as much as 16 times that of the lowest group in the same year. Given these substantial differences in profitability, why don't all banks emulate those pursuing the more "successful" (i.e., high R O A ) strategies? To answer this question requires investigation of the reasons underlying the strategies chosen by individual banks or groups of banks and their relative success in implementing them. While sufficiently detailed information to analyze the strategy choices of every bank is not available, there are a number of patterns that appear to be explicable by means of various aspects of the theory presented 118. These percentages are calculated as: Number of banks still in the market in one year which were in the cluster most similar in membership to their previous cluster/Number of banks still in the market in the next year studied. 126 in Chapter Two. 1 1 9 The high loans clusters120 represent the most traditional banking strategy. In Japan the lending emphasis of most foreign banks was long the provision of foreign currency credits to Japanese borrowers ("impact" loans). In essence banks performing this function were involved in a process of matching offsetting needs that brought together the foreign currency (usually U.S. dollar) deposits of depositors and dollar-hungry Japanese borrowers in need of funds for expansion. Because of their de facto monopoly on this market, it was quite easy for foreign banks to make money in the impact loan business. As Mr. Eric Rasmussen, then Vice-President of Chemical Bank, put it, "when our branch was opened in 1972, we were getting about 200 basis points121 or better lending to the largest corporations in Japan. That was nice money, and you didn't have to work for it - just bring it into Tokyo, open up the back of the truck, and shovel it into their laps" (Tokyo Business Today. April 1986, p. 34). Thus, as long as impact loans were important there was little need for critical self-analysis to determine key areas of competitive strength. Once the Japanese banks were allowed into the impact loan business around 1980, however, strategic readjustment began. 119. In principle, one could test some of the predictions of the theory by use of a technique such as multinomial logit to determine whether the hypothesized variables were statistically significant as predictors of the strategic groups to which banks were assigned. In practice, however, the number of groups into which the banks must be separated in order to observe these micro-level patterns is sufficiently large, and the number of banks in many of the groups sufficiently small, that statistically significant results from this type of test are unlikely. These patterns will therefore be discussed below without formal statistical tests. 120. Cluster #4 in 1979, #5 in 1983, #1 in 1986 and #2 in 1989. 121. i.e., a spread of two percentage points. 127 Competitive pressures on profitability in the groups which depend most heavily on lending are likely to be particularly intense once regulatory protection is removed for several reasons. First, all banks have the basic know-how involved, since this is the fundamental activity which defines banking. Second, to the extent that banks are able to have advantages in the general loans market (e.g., more effective sales techniques or credit evaluation processes), such advantages are likely to be easily imitable. For example, one could simply lure away the effective sales people with higher salaries. Third, since foreign banks are marginal lenders in the Japanese market, relationships are likely to be less important than price, so that even banks that are able to offer better service are unlikely to be able to charge much for it. Being marginal lenders largely frozen out of close relationships with top quality Japanese borrowers by the main bank system and largely inhibited from establishing branch networks by regulations and cost factors122 also means that expansion often involves dropping down to second and third-tier businesses with a resulting increase in risk and eventually loan losses. In essence, then, the barriers to entry into the lending-oriented groups are the lowest,123 and price sensitivity is likely to intensify competition even further. Not surprisingly, as competition in the high loans groups intensified and aggregate group profits declined from an R O A of .21% in 1983 to -.08% in 1989, many banks moved out of the lending oriented groups, or at least shifted from a high-loans group to a lower loans group. The most noticeable result of this process was the withdrawal of many American 122. As late entrants, foreign banks face a market with prohibitive land costs in which the prime locations have already been taken. 123. Seventeen out of 20 new entrants over the period studied were able to move directly into the mainstream lending-oriented groups. 128 banks from the high loans groups. As late as 1979, over two-thirds of U.S. banks (15 out of 22) were in the high loans group (cluster #4) and this no doubt contributed to their dominant market share in lending (see Figure 4-2). By 1989, however, their share of the loans and discounts market had declined to little more than a fifth of what it had been a decade earlier, their loan total was actually over 12% lower ( ¥ 800,367 million in 1989 vs. ¥ 914,328 million in 1979), and less than a third of the banks were still in the high loans cluster (5 out of 17 in #2). As a result, American banks, which had taken the five top places and six of the top 10 in 1979, took only two of the top 10 places by asset size in 1989 (see Table 4.3.6).124 Banks which have been successful while remaining in the tough high loans cluster have generally had some competitive advantage which either made them a low-cost producer or allowed them to find a specialty niche. The Bank of California, for example, though a relatively small bank, has prospered while retaining a heavy loans emphasis by focussing on short-term, largely trade finance-related credits developed through a network of correspondents in Asia (Japan Economic Journal. Winter, 1988, p. 5). Having been owned by Mitsubishi Bank since 1984 may also have given it rather greater entree with Japanese borrowers than its small size would normally have provided. With these advantages, it has actually been able to increase its profitability in recent years, ranking fifth by return on assets (ordinary income/total assets) in 1986 124. It would be a gross oversimplification, however, to assume that these developments were purely symptomatic of a decline in overall American competitiveness. American banks simply recognized that with their relative decline in size and with their weaker capital base due to their greater participation in the world debt fiasco, they would be better off moving away from the increasingly competitive lending area. As will be discussed later, this frequently involved greater emphasis on the more innovative areas of banking where the Americans continued to maintain a competitive edge. 129 and sixth in 1989. The Bank of Nova Scotia has often been considered Canada's most traditional bank, a "follower" rather than a leader (Report on Business. November 1985, pp. 38-44). By relying on tight cost control and unusually close supervision of lending decisions by a handful of top executives with life-long careers at the bank,125 it has aggressively pursued big-ticket loans such as those used to finance real estate and leveraged buy-out (LBO) transactions (Globe and Mail. February 27, 1990, p. B15) while maintaining the Canadian banking industry's best record for loan losses for nine years (Globe and Mail. April 14, 1990, p. B6). Not surprisingly, BNS Tokyo was not only in the high loans clusters, but also had the highest ratio of loans to assets of any Canadian bank in 1983 and 1989, and the second highest in 1986. German banks have also consistently been classified into the high loans groups.126 Even in 1986, when a separate "high loans" group was not formed, German banks took four out of the top 11 places by loans as a percentage of assets. Highest that year was the Bayerische Vereinsbank (sixth by loans as a percentage of assets). This emphasis would appear to reflect the bank's principal corporate area of expertise, as it is "one of the three institutions in West Germany authorized to operate as a long-term credit bank," and accordingly Dr. Peter B. Baron, General Manager of its Tokyo branch, stated in an interview with the Japan Economic Journal that "the loan business is the centre 125. Speaking about Chairman Cedric Ritchie, who joined the bank after high school and was then 62, one analyst has been quoted as saying "it makes me feel good that he has such a big hand in the credit granting end of the business," since the size of loan which requires top level approval (about $25 million) is much smaller than at most banks (Globe and Mail. April 14, 1990, p. B6). 126. Five (Commerzbank, Deutsche Bank, Westdeutsche Landesbank, Dresdner Bank and Bayerische Vereinsbank) were in #4 in 1979, #5 in 1983 and #2 in 1989. 130 of our current activities here in Japan and is the major income source for the Japan branch" (November 14, 1987, p. 12). Among the poorest performers in the mainstream average to high loans clusters (#1 in 1986 and #2 in 1989) have been the Singaporean and Hong Kong banks. Without any clear advantage in the lending market (small size, low level of geographical diversification, unimpressive capitalization, etc.), their success has been minimal, as shown by their low assets per employee (see Table 4-10). Of the four Singaporean banks (Development Bank of Singapore, Overseas Union, United Overseas and Overseas Chinese) and the Hongkong and Shanghai Banking Corporation, three lost money in 1986 and all five did in 1989. Thus, banks that attempt to remain in a traditional area when competition intensifies seem to fare rather poorly. One of the groups to which U.S. banks moved as they shifted away from lending was the "low loans" group. These moves appear to have been made to capitalize on other competitive strengths which these banks have developed. Bankers Trust, for example, has refocussed its overall efforts away from traditional lending, closing many of its domestic branches to focus on sophisticated corporate trading and correspondent (interbank) services. Its Tokyo branch has reportedly adopted a similar focus (Euromoney. February 1988, pp. 40-42). Bank of Boston, on the other hand, has capitalized on its long tradition of financing trade in Latin America to develop a similar niche in Japan,127 resulting in it having one of the five lowest ratios of assets per employee in 1986, while still being quite profitable. In both cases, then, moves from the high loans group in 1979 to the low loans group by 1989 would appear to be primarily 127. Author's interview with branch manager, April 1989. 131 a reflection of the revealed competitive advantage of these banks once regulatory protection was removed from straightforward lending. Security Pacific Bank, on the other hand, has long had lower reliance on traditional lending activities. This approach corresponds to the bank's "stated objective" of having "non-banking operations... be the fastest growing part of the company" (Wall Street Journal. December 8, 1982, p. 20). In particular, Security Pacific's overall strategy has reportedly emphasized investment banking, including forming a joint venture investment advisory company with Sumitomo Trust and Banking (Wall Street Journal. October 29, 1985, p. 5) and investing U.S. $300 million in advanced trading facilities and other investment banking infrastructure (Wall  Street Journal. October 6, 1987). This strength came through clearly in the Japanese branch's; operations, as the bank was second highest by securities holdings ratio and highest by guarantee bookings ratio128 in 1983 and eighth and fourth respectively in 1986. Among the most striking characteristics of the high deposit groups129 has been the preponderance of Korean banks. Although they comprise only about one twelfth of the foreign banks in Japan, they have represented one-third to one-half of the banks in these clusters. Although most foreign banks have had difficulty penetrating the market for deposits in Japan due to the difficulty and expense of finding suitable branch locations (Economist. July 7, 1990, p. 7), not to mention earlier regulatory restrictions, several of the Korean banks have generally been relatively successful in raising deposits. This would seem to reflect the advantage of having an ethnic Korean community within Japan which is likely to prefer to deal with a Korean bank for cultural or patriotic reasons. 128. i.e., securities (guarantees) as a percentage of total assets. 129. Clusters #1 and 3 in 1979; #3 in 1983; and #5 in 1986. In 1989 they were in #3, which was the cluster with the second-highest average level of deposits. 132 Koreans form by far the largest contingent of non-Japanese permanent residents in the country (about 680,000) and have kept a strong sense of identity due to various regulations that have emphasized their distinctiveness (e.g., a requirement for compulsory fingerprinting as resident "foreigners," which is only now being relaxed for some second and third generation Korean residents of Japan). Several other factors point to an ethnic retail orientation. Although they are among the most profitable foreign banks in Japan by R O A (see Table 4-11), they are among the lowest in terms of assets per employee (see Table 4-12), which is consistent with a high margin, small transaction type of business. Four of the seven also have branches in Osaka, which has a relatively high concentration of residents of Korean origin (De Vos et al., 1983, p. 3).130 The extremely high profitability of several of the Korean banks relative to others in the high deposits group again points to the importance of entry (or, to use Caves and Porter's (1977) term, "mobility") barriers that protect the profits of banks in some niches. The "Koreanness" of these banks cannot easily be imitated by other foreign banks, and therefore provides considerable insulation to them from competitive pressures. Moreover, since they have been government owned or controlled for most of the period under study, they have had little incentive for profit-destroying rivalry. 130. The unusual characteristics of the Korean banks may also be a reflection of the importance of Japanese-Korean trade, however here as well the ethnic factor is likely to be important as Korean businessmen are probably more likely than most to prefer to deal with a home-country bank given the uneasy history of relations between the two countries. While it is purely anecdotal, additional corroboration of the ethnic orientation of the Korean banks comes from the author's experience in phoning them to request information. Al l answered the phone in Korean, and several had great difficulty finding anyone who could speak even the most rudimentary English or Japanese. This was in sharp contrast to all other banks phoned which answered in English or Japanese. 133 Another bank which has emphasized the consumer market and hence is in the high deposits group is Citibank.131 It is one of the few banks (and certainly the most successful one) with the international consumer banking skills to attempt to penetrate the consumer market on a world-wide basis. In addition to its years of consumer banking experience in many countries (typically focussing on well-to-do, internationally mobile clients), Citibank also has decades of knowledge of the Japanese market, having been in the country since 1902.132 Not surprisingly, one of the niches Citibank has chosen to pursue since the end of the impact loan bonanza is the consumer banking market (Globe and Mail. January 19, 1988, p. B30; Tokyo Business Today. January 19, 1990, pp. 32-35). This effort has included an early decision to expand its network to six branches in Japan despite regulatory hurdles (Wall Street Journal. July 17, 1981, p. 30) and an unsuccessful attempt to acquire Heiwa Sogo Bank, a retail-oriented institution with 101 branches, 63 of them in Tokyo (Wall Street Journal. December 27,1985, p. 5). Citibank has also signed agreements with Dai-ichi Kangyo Bank to give its customers access to DKB's A T M network (Wall Street Journal. December 23, 1987, p. 12) and with the Postal Savings Bank system for the sale of its overseas remittance services. Most recently it has agreed to pay ¥ 1 1 5 million plus ¥ 4 million a month for access to BANCS, the nationwide interbank network of over 20,000 A T M s in Japan (Wall Street Journal. May 11, 1989, p. A l l ; Economist. July 7, 1990, pp. 77-78). While these operations are not yet profitable, according to Mr. Masamoto Yasuhiro, the bank's chief country officer 131. Obviously, a bank the size of Citibank has other important areas of expertise, however its consumer initiatives in Japan have received by far the most attention. 132. Although First National City Bank (FNCB) re-established its branch in Japan only in 1950, a predecessor, the International Banking Corporation (IBC), had opened in Japan in 1902. IBC was acquired by F N C B in 1916 (Bratter, 1931, p. 269). 134 in Japan, Citibank is "heavily investing today so that maybe in 10 years... [they] will be truly profitable" (Wall Street Journal. April 20, 1990, p. A l l ) . Thus Citibank's move from the high loans clusters in 1979 and 1983 (#4 and #5) to the high deposit cluster in 1986 (#5), and the cluster with the second-highest deposits in 1989 (#3)133 should be interpreted as a strategic move congruent with the bank's expertise rather than as a failure to stay in the high loans group in later years. Another persistent strategy followed by a relatively small number of banks has been to rely very little on inflows of funds from the parent. There appear to be two distinct reasons for following this strategy. The two Brazilian banks, Banco do Brasil and Banco do Estado de Sao Paolo, are consistently grouped together from 1983 to 1989 in clusters with low reliance on their head offices for funding.134 In fact, in all these years the Brazilian banks were actually among a very small group of banks (the only ones in 1983) which were net suppliers of funds to their head offices (see Table 4-13), and this tendency appears, if anything, to be increasing. This pattern of behaviour is as one would expect for banks from a heavily indebted country experiencing severe payments problems. Instead of focussing on expanding lending activities as most banks do, these branches' primary role appears to be to provide access to local capital markets. In return for this access, a lower level of profitability seems to be accepted, particularly by state-owned Banco do Brasil, whose profitability has generally been near or below zero.135 Similar reasoning may also explain the Bank of Credit and Commerce International's 133. In 1989 Citibank had the highest reliance on deposits and correspondingly the lowest reliance on head office funding of any U.S. bank. 134. Cluster #4 in 1983, 1986 and 1989. One of the two was in a similar cluster (#1) in 1979 as well. 135. R O A was .06% in 1983, .008% in 1986, and -.006%- in 1989. 135 presence in this group. BCCI has been rapidly expanding around the world, yet lacks a home country deposit base.136 Thus, it may have seen Tokyo as a good potential source for the funds needed to maintain its growth. In fact, it has been reported that BCCI had a worldwide policy "that came down from the highest levels of the bank: to take in as many deposits as you can, and not to be too careful about where they came from" (Michael L . Rubinstein, U.S. federal prosecutor, Wall Street Journal. May 3, 1990, p. 1). The Bank of New Zealand's vigorous adoption of a "funds withdrawal" strategy is also consistent with its home country's position as a major borrower (relative to its size, at least). The other motivation for a funds withdrawal strategy is quite different, and is exemplified by the Toronto-Dominion (TD) Bank, which has long had a strong North American emphasis to its lending activities. By insisting on relatively high yields on its loans it has achieved the highest R O A and R O E of any Canadian bank, as well as the highest stock market return.137 It was also the last Canadian bank with an A A A credit rating, a fact which has no doubt contributed to its relative success in attracting deposits.138 Thus, given the bank's chief characteristics~an admitted relative lack of expertise and interest in non-North American credit and a strong ability to raise local deposits - it should be no surprise that its Tokyo operation was also in the low loans, low 136. BCCI was founded by a Pakistani, its legal headquarters are in Luxembourg, its chief operational centre is London, and its ownership, while somewhat mysterious, appears to be concentrated in the United Arab Emirates. 137. For example, in 1988 and 1989, its R O A was 1.17% and 1.14%, while no other Canadian bank exceeded .75% in either year (Price Waterhouse, 1988, 1989). Its 10-year stock market return was also reported to be over twice that of its nearest competitor (Report on Business. October 1989, p. 52). 138. The T D was second among the Canadian banks in 1986 and first in 1989 in terms of deposits as a percentage of assets. 136 head office cluster in 1986 (#4) and the low loans, low head office, high deposits cluster in 1989 (#4). In fact, in both these years it was among the lowest six banks as ranked by reliance on head office funding and by loans as a percentage of total assets. In 1983 it was also in the lowest five by loans as a percentage of assets, but having just opened the year before,139 it was more heavily reliant on head office funding than any other bank. Another small group of banks has consistently pursued a strategy characterized by heavy reliance on guarantee business.140 Grindlays Bank, for example, has a very strong international branch network due to its origins as a British colonial bank. Operating in a large number of LDCs gave it substantial experience in trade financing, and this appears to have been the niche it pursued in Japan as well. In both 1979 and 1983 it was in groups with high guarantees and below average loans.141 A N Z Bank, which took over Grindlays, including its Japanese branch, was similarly categorized as a "high guarantee" bank in 1986 and 1989.142 Lloyds Bank, another ex-colonial bank, has also been in high guarantee groups throughout most of the period under study, probably for similar reasons. This group also includes perennial top performer, the National Bank of Pakistan. With virtually no FDI by its home country, no significant resident expatriate population to service, and little reputation for advanced banking skills, it would appear that NBP achieves its high returns by serving trade-related business such as letters of credit, remittances, etc. This conclusion is strengthened by Table 4-10, which shows the 20 lowest banks by branch assets in Japan per branch employee in 1986. Banks which 139. Canadian banks were not allowed restrictions. 140. There were two such groups in 1983. 141. Cluster #5 in 1979 and #2 in 1983. 142. Cluster #2 in 1986 and #5 in 1989. into Japan until 1981 due to reciprocity 137 have low reliance on loans and few assets per employee yet are highly profitable tend to be involved in processing related businesses such as letters of credit, trade finance, etc.143 The last type of group found is relatively new, appearing in 1986 for the first time. Its distinguishing feature is heavy reliance on securities holdings and a very high level of average profitability (second highest in 1986, highest in 1989). Unfortunately, little can be said about this group due to its relatively newness and rapid turnover (only one of the three banks in it in 1986 was still in it in 1989). It is possible that this group may consist of opportunistic banks which periodically find a few attractive opportunities, rather than of banks with a long-term commitment to this approach. The above discussion, by linking the strategies pursued in Japan to the parent banks' overall competitive advantages and strategies, shows why foreign bank branches are often not able to easily emulate the local strategies of the banks in the most profitable strategic groups: these strategies require competitive assets which the would-be imitators simply do not have, i.e., there are substantial mobility barriers which protect profits in certain market niches. For example, the National Bank of Pakistan has consistently had the highest R O A of any foreign bank by confining itself to a niche where it can be competitive: the processing of trade transactions between Japan and Pakistan. It would likely fare poorly if it were to venture outside this niche, and would-be entrants would probably find it unprofitable to make the investment in infrastructure 143. The author's interviews with three of the banks in Table 4-10 in April 1989 (Overseas Chinese Bank, Bank of Boston, and the State Bank of India) confirmed a high reliance on trade finance. Overseas Chinese Bank had also tried to emphasize local currency lending but found margins in that business extremely poor. 138 in Pakistan necessary to out-compete NBP in this tiny niche.144 Similarly, only Korean banks have an advantage with ethnic Korean residents in Japan and with Korean businessmen trading with Japan because of linguistic, cultural and patriotic factors. Table 4-11 shows that many L D C banks have been quite profitable in Japan by pursuing such defensible niches. Banks which lack these "natural" franchises must rely on the skills they have acquired over time, such as Citibank's consumer expertise, Grindlay's trade finance experience, etc. Here again there are barriers to imitation, since these advantages can only be developed over time, but the potential for breaching these barriers is greater than where they are inherent in the bank's nationality. The differentiation between banks with strong natural or acquired advantages congruent with their local strategies and those without will, of course, be greatest when the overall downward pressure on profits is strongest. In Japan, this generally occurs during periods of easy money, since the foreign banks are for the most part marginal lenders in the credit market (Mainichi Daily News. December 15,1977, p. 10). During periods of tight money, Japanese borrowers frequently turn to foreign banks for the loans their traditional banks cannot provide, thereby giving almost all a chance at lucrative lending opportunities. It was recently reported, for example, that the latest round of monetary restraint, which has pushed up Japanese interest rates to record highs, has been a bonanza for foreign banks, particularly those from Europe. Within a few weeks, loans by foreign banks jumped 60%, increasing their market share from 1.6 to 2.4%. This was accomplished without much effort, because "concerned about presenting cleaner balance sheets at the end of March, while they were often exceeding authorized credit limits, 144. Even if allowed to by Pakistani banking regulations. 139 Japanese banks even acted as guarantors of borrowers' solvency" (Globe and Mail. June 11, 1990, p. B8). While such fluctuations may mask some of the differences among banks temporarily, in the long run each bank's profitability is likely to depend on its strength in the niche it pursues, as well as the nature of the niche itself.145 4.3.2 Korea Figure 4-3 and Tables 4-14 to 4-16 summarize the results of the cluster analysis for Korea. As was done for Japan, various maxima from two to six were specified for the number of clusters for each year. Since in two out of three cases only three clusters were found when a maximum of four were allowed, the number of strategic groups in Korea appears to be somewhat lower in Korea than Japan, i.e., about three or four instead of five or six. This is as one would expect in a market which is still more heavily regulated and hence allows somewhat less latitude (and incentive) for banks to pursue individualistic strategies. The stability of the clusters is somewhat greater than was the case for Japan: 80% between 1983 and 1986, 63% between 1986 and 1989, and 71% overall.146 There are at least two reasons for this greater stability. First, in general with fewer groups and fewer clusters one obtains a higher level of stability. Second, the Korean banking environment has not changed as much as Japan's and hence there has not been as pressing a need for strategic realignment by foreign bank branches. The influence of the latter factor can be seen in several ways. First, the differences in profitability among the groups, while still important, are much less than in Japan, with the highest group having average 145. As noted earlier, banks with extensive off-balance sheet business will tend to have a higher R O A than those which emphasize lending due to the former's smaller asset base. 146. See Section 4.3.1 for the definition of stability used here. 140 profitability only about one and one-half to two times as high as the lowest group. Second, even the lowest groups are still reasonably profitable (about .66% R O A ) . 1 4 7 Third, the stability dropped from 80% to 63% over the period of the greatest change in the banking environment affecting foreign banks, i.e., the 1986-88 period which saw Korea move from its traditional position as a major capital importer to a position of exporting capital to reduce its very heavy debt burden.148 Regulatory rigidities (e.g., availability of swap quotas) may also have contributed to the observed stability. Table 4-17 lists the means of the clusters on each variable. As in Japan, most of the banks fall into one of two mainstream groups varying slightly in their emphasis on lending. In 1983, 35 out of 40 banks were in the two average groups. By 1986, 20 of the 22 which had been in the most "average" cluster (#2) in 1983 were still in the "average" cluster (#2), and nine of the 13 which had been in the high loans cluster in 1983 (#3) were still in such a cluster in 1986 (#3). Six out of the seven new entrants in the 1983-86 period also entered one of these two "mainstream" groups. The 1986-1988 period, during which it became much more difficult to find lending opportunities, saw most of the high loans banks (twelve out of thirteen) move into an "average" group (#1) which nevertheless had the highest degree of reliance on loans of any of the groups. The 1983 average group (#2), however, proved rather less stable, as just over half (14 out of 26) of the banks from that group stayed in the most similar 147. For reasons of data availability, R O A figures for Korea are after-tax net income/total assets rather than pre-tax ordinary (recurring) income/total assets as was used in the Japanese analysis. 148. Most recently Korea's debt has again begun to climb, as "net foreign debt (outstanding foreign debt less external assets) has risen by U.S. $1.4 billion in 1989 to U.S. $4.4 billion at the end of March 1990. This represents the first increase in Korea's foreign debt since 1985" (External Affairs Canada, North Asia Bulletin. Vol . Ill, No. 25 (June 22, 1990), p. 3). 141 group in 1988. Of the remainder, one-third moved into the average-high loans cluster (#1), one-third merged, were bought out or closed, and the rest split evenly between the other two groups. Apart from the degree of lending emphasis, the other primary characteristics distinguishing among the clusters were securities holdings (1983 and 1986) or deposit bookings (1988). As was the case with Japan, in each year it was one of the smaller strategic groups which had the highest average profitability, although, as noted above, the differences were not as great in Korea. Because of the somewhat lower intensity of the competitive pressure on foreign bank profits in Korea, there has not been the same urgency to focussing on key areas of individual competitive advantage. Nevertheless, several patterns emerge which again are consistent with the theoretical discussion in Chapter Two. The most striking pattern in the Korean cluster analysis was that all the Japanese banks were always grouped in the clusters with the highest loans.149 In fact, in terms of the percentage of assets comprised of loans, Japanese banks took the top two spots and five of the top six in 1983,150 the top four spots and five of the top seven in 1986 (none ranked below twelfth), and the top three spots and six of the top nine in 1988. (See Table 4-18.) As a consequence of this heavy reliance on lending, the Japanese bank branches in Korea are also among the most dependent on head office funding. Japanese banks took the top four spots and five of the top 10 by reliance on head office funding 149. Nine out of nine were in cluster #1 in 1988, seven out of seven in #3 in 1983, and five out of six in #3 in 1983. The only exception in 1983, Sumitomo Bank, had just opened a few months earlier. 150. The only exception was Sumitomo, which as noted above, had just opened. 142 in 1983, the top three spots and five of the top 10 in 1986, and the top five spots and six of the top 10 in 1988 (see Table 4-19). Another result of this lending emphasis is relatively high assets per employee. In 1986 (the only year for which employment data were available), the Japanese banks took the top three spots and five of the top 10 when ranked by this variable (see Table 4-20). What accounts for this unusual reliance on lending? Two factors would appear to be at work. First, Japanese banks still lag in international expertise, and hence are unlikely to be competitive in one of the few other areas in which foreign banks can compete. Second, and probably more importantly, Japan is by far the largest foreign investor in Korea. As can be seen in Table 3-26, in mid-1987 Japan had almost twice as much FDI in Korea as the next largest investor, the United States (U.S. $2.1 billion vs. U.S. $1.2 billion). Given the perennial shortage of finance in Korea, particularly among foreign joint ventures (Moskowitz, 1989), it seems likely that the success of the Japanese banks is related to the presence of opportunities to lend to customers who have expanded into Korea, usually by means of joint ventures. This, after all, is a situation with exactly the circumstances in which the desire to deal with a home country bank should be the strongest: an investor country whose distinctive culture makes the transactions costs of dealing with fellow countrymen substantially lower than the cost of dealing with foreigners, and a rapid rate of increase in FDI, which leads to the presence of many new subsidiaries or joint ventures that are likely to be particularly thirsty for funds and unfamiliar with the local environment. Another factor which indicates the Japanese may be dealing with companies with whom they already have strong relationships in Japan is their relatively low profitability. Despite their high assets per employee figures (see Table 4-20), the Japanese banks are among the least profitable 143 in their high loans clusters. As Table 4-21 shows, Japanese banks took the bottom two and four of the lowest five positions by R O A in their cluster in 1983, the bottom five in 1986, and the bottom six in 1988. Given the aforementioned scarcity of loans in Korea, Japanese banks do not seem to be taking full advantage of their lending strength, and the most likely reason for this would be that they are lending to subsidiaries of customers whom they do not want to alienate.151 Also consistently in the high loans clusters was the Bank of Nova Scotia. As mentioned in Section 4.3.1, BNS has a strong lending emphasis both at home and abroad, and its success in this area in Korea would appear to reflect its overall strength in the traditional lending business. The most noticeable feature of the "average" groups152 was the dominance of U.S. banks until 1986. In 1983, 10 out of 14 U.S. banks were in the "average" group, while in 1986, 12 out of 15 were. By 1988, however, only four out of 14 were in the "average" group, with the rest having dispersed into more specialized groups. As can be seen in Figure 4-4, the market share of the American banks has declined substantially in the loan market from 1983 to 1988. This decline, however, has not been as precipitous as in Japan, and as a result, there are almost as many U.S. banks in the top 10 by size in 1989 as there were in 1983 (four versus five - see Table 4-22). 151. During an interview with the author, one Japanese bank branch manager expressed complete satisfaction with his branch's operations, which focussed on Japanese joint ventures, even though the branch had very low reported profitability. This is consistent with many of the benefits of the branch accruing elsewhere, e.g., through improved relations with parent companies in Japan or fellow members of the bank's keiretsu (industrial group). 152. Cluster #2 in 1983, #2 in 1986, and #1 in 1988. 144 As in Japan, however, the reduced market share of U.S. banks appears in many cases to have been the result of conscious decisions by American banks to pursue activities more in line with their strategic advantages as the profits from pure lending operations shrank. While the reduction in loan profitability has not been as dramatic as in Japan, the difficulty of funding local currency loans has increased as swap limits and the guaranteed profit margins on them have been cut without the creation of viable alternative funding sources. As a result, banks have been forced to seek out other sources of profit, many of them of a short-term, non-recurring nature (American Chamber of Commerce in Korea, 1988, p. 2). One of the groups to which American banks shifted as they moved out of lending was the "high guarantees" group. This group seems largely comprised of trade finance-oriented banks. For example, (First National) Bank of Boston, which has, as noted in Section 4.3.1, reoriented its Tokyo operation towards trade financing transactions such as negotiating export letters of credit, appears to have taken a similar tack in Korea, moving from the middle of the pack in reliance on lending in 1983 to a position as one of the 10 lowest in 1985 and 1988. Correspondingly, it was one of the seven lowest in reliance on head office funding in both 1986 and 1988 and had the third highest ratio of guarantees to total assets in 1986 and the ninth highest in 1988. Once again this reorientation appears to have paid off, as R O A increased from a substandard .25% (eighteenth out of 22 in its cluster) in 1983 to .72% in 1986 (sixteenth out of 26 in its cluster) and finally to 1.42% (fourth out of twenty-three in its cluster) in 1988. American Express Bank, which also emphasizes L D C trade finance, is another American bank which has shifted into this group as lending has become less attractive. Many of the non-U.S. banks in this group are also well-known for their trade-145 finance activities. Standard Chartered, Lloyds, and A N Z (formerly Grindlays) all have extensive L D C branch networks which have led them to focus on financing trade among such countries, and between them and the industrialized world. Bank of Credit and Commerce International, which was established largely to finance trade, and hence has an unusually large number of overseas offices relative to its size, is also in this group. In fact, even before a separate trade finance-oriented group was formed, its pattern of activities was quite different from the "average" banks with which it was grouped. As Table 4-18 shows, in each year under study, BCCI had the lowest reliance on loans. It also had the highest reliance on guarantees in 1986 and 1988, and the fifth highest in 1983. BCCI is also unusual in that it had the highest proportion of deposits in 1983 and 1986, and the third highest proportion in 1988. So low were its lending activities and so active its deposit collection that in all three years under study its branch had the lowest reliance on head office funding of any foreign bank in Korea and actually was a net supplier of funds to its head office in 1983 and 1988, the only bank in either year to be in such a position. This behaviour once again emphasizes the single-minded drive for deposits which has characterized BCCI's strategy (Wall Street Journal. May 3, 1990, p. 1). This strategy is in itself understandable given the bank's lack of a true home country market to provide a core of deposits. The smallest group formed during the period under study was the 1988 "low head office funding, low loans" group, which consisted of only two American banks, Bankers Trust and Chase Manhattan. Once again this finding seems to correspond to what is known about the parents' relative strengths. In particular, as discussed earlier, one of the boldest overall strategic initiatives undertaken in banking in recent years has been Bankers Trust's decision largely to withdraw from traditional banking, to sell off its retail 146 branch network, and to focus on corporate and interbank services to capitalize on the strengths developed as one of New York City's leading banks in these areas. The results of this strategy are also visible in Korea, where Bankers Trust moved from being almost at the median in reliance on loans in 1983 (twenty-second out of 40) to having the fourth lowest reliance on loans among American banks (eighth lowest overall) in 1986 and the lowest among American banks and second lowest overall in 1988. Correspondingly, Bankers Trust had the third lowest reliance on head office funding in 1988 and the highest level of securities holdings relative to assets. It was also the most profitable bank both in its cluster and overall in terms of return on assets, having more than quintupled its R O A in five years (from a below average .54% in 1983 to the top ranked level of 2.99% in 1988). Abandoning a mainstream strategy for one more reliant on the bank's specific competitive advantages thus seems to have been amply rewarded. In both 1983 and 1986 high securities groups were also formed. A high deposits group with the second-highest level of securities holdings was formed in 1989 as well. However, as in Japan, this type of group does not appear to be very stable, as only three out of five banks stayed in it from 1983 to 1986, and two out of seven stayed in it from 1986 to 1989. Thus it appears again that this strategy may be more of an opportunistic one, with banks either responding to especially enticing opportunities, or perhaps just parking excess funds in securities. The relatively high profitability of this group, particularly in 1983 and 1986, however, argues for the former explanation. 4.3.3 Conclusions from Post-Entry Competition Analysis Consideration of the strategic groups analysis above, particularly in combination with the earlier Model I and Model II statistical results, gives a clearer picture of the actual role of some of the theoretical sources of advantage discussed in Chapter Two in 147 determining a bank's profitability and hence incentive to enter a foreign market. As long as the foreign banks had a protected and relatively uncrowded niche, almost all banks could earn comfortable profits from very unimaginative transactions cost reduction strategies which relied on their privileged position in bringing together foreign dollar depositors and Japanese dollar borrowers. U.S. banks in particular were able to carve out dominant market shares due to their more direct access to U.S. dollar markets. Once artificial protection began to disappear in Japan and trade surpluses decreased foreign currency borrowing needs in Korea, it became more necessary to focus on other areas of advantage. One of these was transactions cost reductions possible from handling both ends of a trade transaction. The many L D C banks which prosper by handling trade with their home countries and the ex-colonial banks which focus on trade between countries in their branch network are cases in point. That the former have generally outperformed the latter may tend to indicate that linguistic or cultural factors are particularly important, but is more likely the result of restrictions on the activities of foreign banks in LDCs which inhibit them from having as large a customer base from which to derive such "captive" transactions. Information production advantages in dealing with home country subsidiaries appeared to be important only to Japanese banks in Korea, where most of the joint ventures are relatively new. It would therefore appear that of the various explanations offered earlier for the lack of significance of the FDI variable coefficients, the one which is the most probable is that which focusses on the drying up of lending opportunities to mature subsidiaries which have blended into the local scene. Information production and transactions cost reduction advantages in dealing with host country nationals appeared to be important only for Korean retail-oriented banks 148 in Japan, however for this specific group of banks they appeared to be very important indeed, making them among the most profitable of all foreign banks in that market. In each of these cases, superior performance, whether in terms of profits for the L D C and Korean banks, or loan growth in the case of the Japanese in Korea, was primarily possible because of the mobility barriers protecting the banks' specific market niches rather than any inherent superiority of one type of advantage over another. Since these banks' advantages were based on their nationalities or (in the case of the ex-colonial banks) presence in many L D C markets with strong entry barriers, would-be competitors cannot easily emulate their winning ways. Similarly, first-mover advantages may provide some protection to a few banks such as Bankers Trust, which has a solidly entrenched position in the interbank services market. Most of the other banks have focussed on diverse areas of acquired advantages which by their nature are more vulnerable to attack. Investment banking, trading, or credit adjudication skills, while important, are imitable, though not always easily due to labour market rigidities and the level of geographical diversification necessary to pursue them.153 For example, Citibank's foray into consumer banking in Japan requires asset transformation skills necessary to come up with products appealing to high-income consumers and information production and monitoring skills originating in home country experience in consumer banking and adapted with the help of the bank's long experience in the Japanese market. It also requires substantial financial staying power to acquire or lease expensive locations and withstand lengthy start-up periods. 153. Since trading and investment banking activities involve bringing together parties with offsetting needs, having a large, geographically diversified clientele makes the pursuit of such strategies much easier. 149 The notion of instability may provide a further explanation for the lack of significance of the bank-specific technology variables in the earlier Japanese analysis: not only are such advantages only helpful to banks competing in certain niches, they are also relatively easily copied when domestic banks are relatively advanced and hence provide less of an incentive to enter than unique, "natural" advantages. When local banks are unable to copy them due to the "technological gap," however, such advantages may still be helpful, as was found in the Korean Model II analysis. The strategic groups approach may also help to explain why the coefficient on trade was either negative or not significant in the earlier analysis. As Porter (1979) pointed out, rivalry within a group may destroy its profitability. Since the largest trading partners of both host countries each have several banks in each, they may compete away any abnormal profits.154 What the competitive analysis presented in this and the preceding subsections has shown is, in short, that to the extent that detailed information is available, it is consistent with the importance of the fundamental sources of competitive advantage proposed in Chapter Two, and that these factors explain most of the striking features of banks following unorthodox strategies, or following orthodox strategies with unusual success. While it would also be desirable to be able to explain the activities of more mainstream banks, such analysis will have to await the compilation of a data base with a much larger number of host countries (when and if such data become available) in order to achieve the requisite sample size necessary for formal statistical analysis. 154. In addition, of course, many of Japan's exports are to Japanese subsidiaries abroad, which reduces opportunities for foreign banks to handle both ends of a transaction. 150 The foregoing analysis also demonstrates that the importance of having bank-specific competitive advantages can be obscured during periods of regulation-induced oligopoly profits, but that these skills move to the fore and dominate the strategies of the more successful banks when regulatory advantages dissipate and competition intensifies. 151 Chapter Five C O N C L U S I O N S This thesis has contributed to our understanding of foreign direct investment in banking in several ways. First, it has strengthened the theoretical foundations of the study of multinational banking by demonstrating how the plethora of ad hoc observations which had previously been advanced to explain this phenomenon can be reduced to a few coherent themes by classifying them according to their relationship to the fundamental roles of financial intermediaries, i.e., reduction of transactions costs, asset transformation, information production, monitoring, and signalling. This may lay the groundwork for the further integration of the theories of financial intermediation and of multinational banking, which have heretofore proceeded in virtual isolation from one another. On a methodological level, several new techniques have been introduced to the field. Their value, however, lies not in their novelty, but rather in their ability to make better use of the data available. Specifically, the survival time and multinomial logit models allow, under appropriate circumstances, the use of data on non-entrants as well as entrants. Such datasets provide substantially greater variation in the independent variables and hence make possible more powerful hypothesis testing. In addition, these methodologies, by relying on the implications of the parent banks' overall incentive to enter a market, take into account the fact that not all-and in many cases, perhaps not even much of~the benefit to the bank as a whole is reflected in the balance sheet or income statement totals of the overseas branch. The cluster analysis technique, while not allowing direct hypothesis testing, can be a useful tool for the "dissection" of data 152 sets, pointing out patterns worthy of more detailed micro-level analysis (SAS, 1985). Its utility will no doubt increase as deregulation allows banks the scope to focus more narrowly on their individual areas of competitive advantage, and as increased competition forces them to do so. Empirically, proxies for most of the theoretical factors hypothesized to motivate the international expansion of banks have been found to be significant. Where they were not found to be significant at the aggregate level in formal statistical tests, they were generally found to be important at the niche level in the case study analysis. The statistical results are of particular interest since they were obtained with the simultaneous inclusion of proxies for all the major forces thought to be at work. This is in sharp contrast to most of the earlier published studies listed in Table 1-3, which, for the most past, have found very few variables to be significant, and those only in models which omitted many variables of intuitively obvious importance such as size. Much research remains to be done in this field, however. Additional single country studies can shed light on aspects of the theory which may be particularly relevant in the specific circumstances of the countries chosen, and can contribute to the building of the database necessary for large, cross-sectional multi-host country studies. Such studies have the potential for substantial contributions to our understanding of the process of country selection by individual banks. Formal analytical modelling of questions of economies of networking155 should proceed in parallel with the development of a database which can be used for investigating such problems. A multi-country database 155. As mentioned in Chapter Two, there are a number of conceptual parallels between bank networks and telecommunications networks. The latter have been studied in works by Rohlfs (1974), Littlechild (1975), Oren and Smith (1981) and Katz and Shapiro (1985), among others. 153 may also allow relaxation of the single-country sampling frame which has limited strategic group analysis to date (Thomas and Venkatraman, 1988, p. 550). Further methodological refinements may also help to clarify the relative importance of the theoretical factors behind the proxies used in this study. For example, is size important because of diversification, reputation effects, or experience? Additional research is needed to answer such questions. Finally, banks are but one form of financial intermediary, and other types of institutions must also be studied and integrated into an overall theoretical framework. As deregulation proceeds in most countries around the world, barriers which have artificially separated the activities of different types of financial firms are likely to dissolve. 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East East Africa area Total United Slates 136 56 21 22 8 67 85 32 126 30 16 207 670 United Kingdom (8) - (11) (3) (3) (4) (52) (14) (18) (4) (7) (12) 028) 20 19 - 21 8 8 72 102 8 503 142 148 83 114 (16) (2) (24) (2) (1) (30) (64) (7) (845) (49) (2182) (81) (3287) France 24 11 13 - 16 10 48 30 7 31 23 30 7 226 (16) (2) - (5) (1) (44) (45) (13) (14) (232) (5) (361) Germany 12 (2) 13 6 2 _ 1 1 (1) 5 12 (1) (1) 7 47 (2) Switzerland 12 (3) 8 (2) 8 4 (1) 3 2 1 7 33 (3) Netherlands 7 8 5 2 8 28 3 10 10 2 10 86 (2) (1) (9) (3) (11) (8) (4) (3) (39) Italy 6 11 4 6 6 1 1 5 1 35 (S) (2) (1) (7) (2) (3) (11) (26) Other Europe 32 18 158 79 7 1 21 22 3 6 1 1 317 (13) (6) (9) (3) (1) (19) (12) (2) (18) (33) (103) Canada 7 28 15 2 6 7 26 11 7 1 140 243 (5) (14) (10) (1) (1) (2) (11) (31) (84) (154) Japan 23 49 22 1 12 6 3 - 29 122 (6) (8) (3) (2) C) - (8) (2) (27) Australia 9 (4) 7 17 (4) 528 (12) 552 (16) Latin America 15 (2) 16 (2) 4 2 (1) 1 4 (1) 39 (1) 2 1 1 1 18 89 (S) Other Far East 47 36 130 4 5 3 1 18 257 81 24 6 565 (17) (2) (4) (6) (10) (108) (4) (12) (146) Mid-East 21 (6) 17 (2) 20 6 (1) 8 3 4 106 (23) 10 (11) 3 177 (37) Africa 15 8 4 13 15 40 (6) (9) (38) (47) Caribbean 1 (1) 13 (7) (2) 13 (9) Total 387 241 466 142 87 27 250 356 79 1518 425 249 489 4329 (112) (34) (40) (39) (16) (6) (123) (229) (34) (1018) (134) (2530) (187) (4390) Figures in brackets refer to 1961. Pecchioli (1983), based on Comptroller of Ihe Currency (1981), pp. 141-143. Figures for Japan are from national sources. ^ 176 Table 1-2 Foreign Network of the World's 100 Largest Banks. 1985 Developing countries Foreign offices of banks Total entities Developed market Total economies South East Latin Asia America Africa Centrally Eight planned offshore economies* centres" All 100 banks Number of offices 4660 2296 2246 - - 118 (Change from 1980) (147) (114) (^ Jl) (74) France (9 banks) Number of offices 688 304 356 84 114 72 28 (Change from 1980) (224) (87) (119) (18) Germany, Federal Rep. of (11 banks) Number of offices 289 176 105 30 45 17 8 (Change from 1980) (-65) (-35) (-34) (4) Japan (26 banks) Number of offices 676 338 300 6 87 215 38 (Change from 1980) (110) (52) (23) (35) United Kingdom (5 banks) Number of offices 457 204 247 69 52 30 6 (Change from 1980) (-29) {-4) (-27) (2) United States (15 banks) Number of offices 884 364 511 64 228 145 9 (Change from 1980) (-280) (-123) (-160) (3) 606 (-29) 75 (35) 31 (-3) 122 (12) 62 (-7) 115 H4) Note: The foreign network includes banks, subsidiaries, affiliates and representative offices. The number of entities in the foreign network of the banks listed is not complete. In most cases, branches and/or representative offices are counted on the basis of countries and/or cities where they are located. Subsidiaries and/or affiliates of foreign subsidiaries are not counted. a. Bulgaria, China, Czechoslovakia, German Democratic Republic, Hungary, Poland, Romania and Union of Soviet Socialist Republics. b. Bahamas, Bahrain, Cayman Islands, Hong Kong, Lebanon, Netherlands Antilles, Panama and Singapore. Sources: United Nations Centre on Transnational Corporations, based on The Banker. August 1986; The Banker, research unit, and Who Owns What in Banking, various years (cited in United Nations, 1988). Table 1-3 SUMMARY OP MAJOR CATEGORIES OP VAR1ABIJ3S POUND SIGNIFICANT AT l l l l ! 95% LEVEL IN EMPIRICAL SIUD1ES OP MULTINATIONAL BANKING Authors) Date Subject Dependent Variables) Market Trade Growth IMP/EXP HOST/HOME Size NET BANK/WORK Regulation Profitability/ Arbitrage Opportunities Other Ball & Tschoegl (1982) Japanese Banks with presence in California Subsidiary/ No subsidiary* + experience in host ( +) P(Subsidiary Presence**) U.S. Banks with presence in Japan Branch/No Branch" + experience in host ( + ) P(Branch Presence **) + Cho (1985) U.S. banks in Singapore and Korea (1975-78-80) Branch Assets, deposits, loans, net income + 10 12 10 12 U.S. banks in Korea (1975-78-80) + 4/4 + 1/4 1/4 host market size ( + ) U.S. banks in Singapore (1975-78-80) 3/4 2/4 due to H.O. and/or aff ( + ) Giddy (1983) 55 Multinational Banks ROA, ROE + + 1/4 1/8 2/4 8/8 business mix 48 Multinational Banks (no state-owned) ROA, ROE + + 1/4 4/8 2/4 7/8 business mix 50 Urge U.S. Banks Foreign profits (total/assets), ROA, Stock returns + 3/16 2/5 business mix 50 Large U.S. Banks 5/15 business mix Goldberg Helsley & 1 xvi 42 Countries Foreign Assets of Banking System + -(1987) 16 OECD Countries 1975-1984 Foreign Assets of Banking System + investment abroad ( +) 50 U.S. States Assets of Foreign Banks within State + # MNCs with H.Q. ( + ) income level ( + ) Table 1-3 - continued AutHorfs) Date Subject Dependent Variabk(s) Market Trade Growth IMP/GXP HOSr/IlOME Size NHr BANK/WORK Regulation Profitability/ Arbitrage Opportunities Other Goldberg U.S. Banks in U.K. & Saunders (1980) Deposits 1961-78 (U.S. reg) + + -. Deposits 1961-68 (U.S. reg) + + Deposits 1968-78 (U.S. reg) + + Deposits 1961-78 (U.Kreg#l) + + Deposits 1961-78 (U.K. reg #2) + + Goldberg Foreign Banks & in U.S. Agency Assets + + - + Saunders (1981) Branch Assets + -Subsidiary Assets + + Nigh, Cho U.S. Banks in 30 & Krishnan countries (and sub-(1986) sets)(1976-82) Branch assets 6/11 11/11 U.S. FDI + Fieleke U.S. Banks in 10 (1979) countries (1974) and 8 countries Branch assets (1974) + (2/2) 1/2 US FDI+ (2/2) host size + (1/2) (1975) Br. claims on/liab to foreign non-banks (1974) + (1/2) 1/2 Branch net income (1974) + (1/2) U.S. branch market share U.S. sub sales + (2/2) Khoury Japanese Banks (1980) in U.S. 1972-77 Commercial Loans + Trade Related Loans ( + ) Table 1-3 - continued Authors) Dale Subject Dependent Variable(s) Market Size Trade Growth NKI' 1MP/EXP HOST/HOME B A N K / W O R K Regulation Profitability/ Arbitrage Opportunities Other Terrell (1979) U.S. Banks in Japan Branch Loans Host monetary stringency ( +) host reserves ( + ) Japanese Banks in U.S. Agency & Branch Loans ( + ) Agency, Branch & Subsidary Loans ( + ) Sabi (1988) U.S. Banks in 23 LDCs Branch Assets (1975-1982) + (2/3) US FDI + (3/3); Host per capita income + (3/3); Bal. of Pmts+ (2/3) Hultman & Foreign subs, in McGee U.S. (1973-86) (1989) Market share agencies in the U.S. (1973-86) Foreign FDI +; Value of Dollar + Foreign branches and agencies in U.S. (1973-86) Market share + Foreign FDI +; Value of Dollar + Japanese offices in US (1974-86) Total Assets + Japanese FDI +; Yen Value of Dollar -Foreign subs, in the U.S. (1973-86) Number of offices Foreign FDI +; Value of Dollar + Foreign FDI +; Value of Dollar + lleinkel & Foreign banks in Levi in the U.S. (1989) (1985) Number of rep. offices + per home country Number of agencies per + home country Number of branches per home country U.S. claims on home-country nationals +; size of home capital market + Size of home capital market + Size of home capital market + Notes 1. Signs ( + /-) indicate significantly different from zero at 95% level in direction indicated. 2. All studies used regression except: " discriminant analysis ** logit regression 3. When more than one regression is summarized on one line, fractions (e.g., 1/4) indicate number of times significant/number of times used. 4. Fieleke (1979), Khoury (1980) and Terrell (1979) do not disaggregate trade into imports and exports. Source: Author's review of listed articles. 180 Table 2-1 Dunning's Eclectic Framework Optimal Mode of Ownership-Specific Internalization Location-Specific International Activity Advantage Incentive Advantage Exporting X X Licensing X X Foreign Direct Investment X X X Source: Dunning (1977, 1979) 181 Table 3-1 (a) Independent Variables: Definitions and Sources Factor Bank Size Level of Ceogrpahical Diversification Skills in Value-added Financial Services Capitalization Distance Relative Operating Costs Reciprocity Pruiy ASSETS = Bank's total assets less contra items COUNTRIES = Number of foreign countries in which the bank has a branch, representative office, or commercial banking subsidiary or affiliate. EXPERTISE « average market share 1979-1983 in foreign exchange trading and lead management of syndicated loans and Eurobond issuance, normalized for size EUROBONDS = amount of Eurobonds lead managed, 1963-67, normalized for size FINPCT = percentage of the home labour force employed in the financial sector COMMPCT = percentage of the home labour force employed in the commerce sector JFDI (KFDI) = Stock of foreign direct investment by companies from the bank's home country in Japan (Korea) IMPORTS = Home country imports from the host country TRADE = Sum of home country exports to and imports from the host CAPRAT = Capitakassets ratio (capital divided by assets less contras) TAIRDIST (SAIRDIST) = Air distance from bank's headquarters to Tokyo (Seoul) in nautical miles RENT =• Rent in US $ per month for a four room luxury apartment of the quality usually provided for expatriate staff OPEN = Dummy variable which equals one if reciprocity exists, zero otherwise (see text) Model H The Banker. Annual Top 500 Listings 1979-86 Banker's Almanac. various years. Euromoney. annual surveys n.a. (see EXPERTISE) above ILQ Yearbook of  Labour Statistics Japan Economic  Almanac (1986), JETRO White Paper  on Investment (1987), Korea Economic  Annual (various years) IMF Direction of  Trade Statistics The Banker. Top 500 listing IATA Air Distances  Manual Union Bank of Switzerland. Prices  and Earnings around  the Globe, various years Model I Banker's Almanac. 1966-67 edition Banker's Almanac 1966-67 edition n.a. (see EUROBONDS below) Euromoney. 25th Anniversary Supplement ILQ Yearbook of  Labour Statistics IMF Direction of  Trade Statistics Banker's Almanac IATA Air Distances  Manual Banker's Almanac Table 3-l(b) Variables Used in Ouster Analysis' 182 D E P = deposits/branch assets in host country S E C = holdings of securities/branch assets in host country L O A N = loans and discounts/branch assets in host country H O = (liabilities to head office and affiliates - due from head office and affiliates)/branch assets in the host country G T E E = customer liability under guarantees and acceptances/branch assets in host country Note: 1. A l l variables standardized to have a mean of zero and a standard deviation of one. Sources: Peat Marwick Minato, Published Financial Statements of Foreign Bank Branches in Japan, various years; Peat Marwick San Tong & Co., Published Balance Sheets of  Foreign Bank Branches in Korea, various years. 183 Table 3-2 Frtreiffn Banlc Branch Opening Chronology: Post WWII Japan 1949: Standard Bank1 1950: Algemene Bank Nederland, Bank of America, Bank of China2, Bank of Korea3, Banque de l'lndochine4, Chase Manhattan Bank, National City Bank of New York5, Hongkong and Shanghai Bank, Bank of India, Nederlandsche Handelsbank6 1953: American Express Bank7 1955: Bangkok Bank 1963: Mercantile Bank8, Overseas Union Bank 1968: Hanil Bank 1969: Morgan Guaranty, Amsterdam-Rotterdam Bank, Bank Negara Indonesia 1971: Deutsche Bank, Manufacturers Hanover Trust Company, Swiss Bank Corp., Wells Fargo 1972: Banco do Brasil, Security Pacific, Chemical Bank, United California Bank', Korea First Bank, Banca Commerciale Italiana, Union Bank of Switzerland, First National Bank of Chicago, Banco do Estado de Sao Paolo, Barclays Bank, United Overseas Bank 1973: National Westminster, Bankers Trust, Banque Nationale de Paris, Overseas Chinese Bank, Irving Trust, Lloyds Bank, Societe Generale, Dresdner, National Bank of Detroit 1974: Rainier National Bank10, Mellon Bank, Crocker National Bank11, Grindlays Bank12, Marine Midland Bank13, Seattle First National Bank14, (First National) Bank of Boston, Bank of California15 1976: Banque de Paris et des Pays-Bas16, Union des Banques Arabes et Franchises (UBAF) 1977: Westdeutsche Landesbank, Development Bank of Singapore, Credit Suisse, National Bank of Pakistan, Commerzbank, Credit Lyonnais 1978: Bayerische Vereinsbank, Midland Bank, Bank Bumiputra Malaysia 1979: Societe Generale de Banque17 1980: State Bank of India * ' • 1981: Bank of Nova Scotia, Bank of Montreal, Royal Bank of Canada, Canadian Imperial Bank of Commerce, Cho-Heung Bank18 1982: Toronto-Dominion Bank, Credito Italiano, Banco Hispano Americano, Commercial Bank of Korea, Credit Commercial de France 1983: Berliner Handels- und Frankfurter Bank, Bank of Seoul and Trust Company1' 1984: Bank of Hawaii 1985: Westpac Banking Corp., National Australia Bank 1986: Shinhan Bank20, Commonwealth Bank of Australia, Bank of Credit and Commerce International, Bank of China (PRC) 1987: Bank of New Zealand, National Bank of Canada 1988: Republic National Bank of New York, Banco Santander 1989: (to March 31): Istituto Bancario Sao Paolo di Torino Notes: 1. Merged and became Standard Chartered Bank 1969. 2. Renamed International Commercial Bank of China 1971. 3. Reorganized as Korea Exchange Bank 1967. 4. Merged and became Banque de l'lndochine et de Suez 1975. Renamed Banque Indosuez 1982. 5. Renamed First National City Bank of New York 1955, First National City Bank 1962, and Citibank 1976. 6. Branch bought by Continental Illinois 1964. 7. Closed 1985. 8. Subsidiary of Hongkong and Shanghai Bank. Closed 1982. 9. Renamed First Interstate Bank of California 1981. 10. Closed 1988. 11. Branch taken over by Midland Bank when it sold Crocker to Wells Fargo 1985. Table 3-2 - continued Notes - continued 12. Bank acquired by A N Z 1984. Branch taken over by A N Z 1985. 13. Closed 1986. 14. Bank merged with Midlantic 1983. Branch bought by Nederlandsche Middenstandsbank 1984. 15. Bank acquired by Mitsubishi Bank 1984 (branch still open). 16. Renamed Banque Paribas 1982. 17. Renamed Generale Banque 1985. 18. Renamed Cho Hung Bank 1985. 19. Renamed Bank of Seoul 1985. 20. Joint venture between South Koreans and Koreans resident in Japan. Sources: Kinvu Zaisei Jiho (August 3, 1987, pp. 89-104); The Banker (September 1977, pp. 124-125); Peat Marwick Published Financial Statements of Foreign Bank Branches in Japan (various years); Euromoney Top 500 listings (various years); The Bankers' Almanac and  Yearbook (various years). 185 Table 3-3 Shares of Total Employable Funds by Type of Financial Institution. Japan. 1955-1980 (%) 1255 1965 1975 1980 City Banks 33.1% 24.9% 19.3% 16.5% Regional Banks 16.1 15.5 13.5 12.6 L / T Credit Banks 4.6 6.1 5.7 4.8 Trust Banks 4.4 6.9 7.2 7.2 Mutual Banks 5.7 7.2 6.2 5.7 Credit Associations 4.0 7.5 8.2 7.7 Rural Institutions 5.3 7.1 8.0 ' 7.4 Post Office 11.6 8.8 13.1 17.4 Insurance Companies 3.5 6.0 6.6 7.1 Other (Including Foreign) 11.7 10.0 12.2 13.6 100.0 100.0 100.0 100.0 Source: Pauly (1987). 186 Table 3-4 The Rise of Japanese Banks, 1979-88' 1979 1983 1986 1988 Rank Bank Assets Bank Assets Bank Assets Bank Assets 1 Credit Agricole 105.0 Citibank 126.0 Dai Ichi Kangyo 240.7 Dai Ichi Kangyo 352.5 2 Bank America 103.9 Bank America 115.4 Fuji 213.5 Sumitomo 334.7 3 Citibank 102.7 Dai Ichi Kangyo 1103 Sumitomo 206.1 Fuji 327.8 4 B. Nat. Paris 98.9 Fuji 103.5 Mitsubishi 204.8 Mitsubishi 317.8 5 Deutsche 91.2 Sumitomo 101.1 Sanwa 192.3 Sanwa 307.4 6 Credit Lyonnais 91.1 B. Nat. Paris 101.0 Citicorp 191.4 Ind B of Japan 261.5 7 Societe Generate 84.9 Mitsubishi 98.1 Norinchukin 162.4 Norinchukin 231.7 8 Dresdner 70.3 Barclays 94.1 Ind. B. of Japan 161.6 Credit Agricole 214.4 9 Barclays 67.5 Sanwa 91.3 Credit Agricole 154.4 Tokai 213.5 10 Dai Ichi Kangyo 66.6 Credit Agricole 90.2 B. Nat Paris 141.9 Mitsubishi Tr 206.0 11 Nat Westminster 64.4 Credit Lyonnais 88.1 Tokai 138.5 Citicorp 203.8 12 Chase 62.0 Nat Westminster 87.1 Credit Lyonnais 132.1 B Nat Paris 197.0 13 W.deutsche Landes 60.1 Societe Generale 86.3 Mitsui 132.0 Mitsui 196.1 14 Fuji 59.8 Deutsche 76.8 Deutsche 131.8 Barclays 189.4 15 Commerzbank 58.3 Midland 76.3 Mitsubishi Tr 127.4 Sumitomo Tr 180.6 16 Sumitomo 58.0 Chase 75.4 Sumitomo Tr 125.2 Credit Lyonnais 178.9 17 Mitsubishi 57.3 Norinchukin 75.2 Nat Westminster 122.9 Nat Westminster 178.5 18 Sanwa 55.3 Ind B of Japan 71.3 Barclays 116.4 " B of Tokyo 171.4 19 Norinchukin 53.7 Mitsui 71.3 Mitsui Trust 116.1 Deutsche 170.8 20 B do Brasil 49.1 Royal 65.6 Societe Generale 116.0 Taiyo Kobe 163.4 21 Bayer Vereins 48.3 B of Tokyo 65.0 LTCB Japan 115.5 LTCB Japan 161.9 22 Ind B of Japan 47.3 Tokai 63.2 B of Tokyo 112.0 B of China 150.4 23 B Naz Lavoro 46.4 Man Hanover 60.9 Daiwa 102.8 Ecureuil 150.3 24 Man Hanover 45.9 Paribas 60.5 Bank of America 102.2 Daiwa 149.2 25 C.C. Raiffeisen 45.3 LTCB of Japan 60.3 Yasuda Tr 101.3 Yasuda Tr 147.2 No. of Japanese: in top 10 1 5 7 9 in top 25 7 10 16 16 Note: 1. Assets less contras in billions of U.S. dollars. Source: The Banker. Annual lists of Top 500 Banks by assets for 1979, 1983, 1986 and 1988. Table 3-5 Market Share of Foreign Banks in Japan, 1971-1976 Deposits Loans 1971 .77% 1.47% 1972 .72 1.44 1973 .96 1.85 1974 1.05 2.45 1975 1.05 3.06 1976 .99 3.37 Source: Mainichi Daily News. December 15, 1977, p. 10, based on Ministry of Finance data. 188 Table 3-6 Profitability and Growth of Foreign Banks in Japan. 1972-79 Return on Assets (%) Asset Growth Rate (%) 1972 n.a. 35% 1973 1.03% 13.3 1974 1.19 57.4 1975 1.12 27.9 1976 .93 21.6 1977 .70 8.3 1978 .60 -2.7' 1979 .29 54.91 Note: 1. Because of fluctuations in the dollar-yen exchange rate, 1978 growth is understated and 1979 growth is overstated. Source: Prindl (1981), p. 71, based on International Business Information Incorporated data. 189 Table 3-7 Profitability of the Foreign Rank Sector in Japan, 1983-89 1983 1984 1985 1986 1987 1988 1989 Aggregate R O A 1 .18% .14% .11% .20% .19% 32% .19% Median R O A .17% .14% .07% .13% .17% .19% .08% High 5.93% 534% 4.67% 5.36%: 4.37% 4.28%3 5.58% Low -2.65% -0.95% -12.70% -1.03% -6.45% -1.82% -13.44% Number of foreign banks in Japan 73 25 76 77 79 81 83 of which R O A = 1% or above 9 8 6 9 10 9 5 .5% to .99% 8 7 8 11 9 17 9 .25% to .49% 14 10 7 11 12 7 13 0% to .24% 21 36 31 31 32 30 26 Losses 21 14 24 15 16 18 30 Notes: 1. Pre-tax net income/total assets 2. Excludes Marine Midland which had an unusually high R O A of 72% as its assets had run down just prior to closing its branch. 3. Excludes Standard Chartered, which had an R O A of 12.26% almost all of which was due to a very large extraordinary item. Source: Peat Marwick, Published Financial Statements of Foreign Bank Branches in Japan, various years. 190 Table 3-8 Comparative Profitability of the Japanese Banking Sector. 1980-84 Country 1980 Return on Assets 1981 1982 1983 1984 Canada1 n.a. n.a. .45 .58 51 France2 .21 .17 .11 .11 .09 Germany3 21 •16 .20 33 35 Italy4 .46 .57 .73 .11 .19 Japan5 .17 .20 .18 .23 .21 Switzerland6 .44 .40 .41 .44 .46 U . K . 7 .97 .71 .64 .53 .38 U . S A . 8 .62 .61 .57 .54 .53 Japan's rank among above 7/7 5/7 7/8 6/8 6/8 Notes: 1. Canadian banks (n = n.a.) 2. Large banks (n = 8) 3. Large banks (n = 6) 4. Large commercial banks (n = 3, 1980-82; n = 8, 1983-84) 5. City banks (n = 13) 6. Large banks (n = 5) 7. London Clearing, banks group (n = n.a.) 8. Large insured commercial banks (n = 191, 206, 230, 253, 274) Source: OECD, Bank Profitability: Financial Statements of Banks. 1980-1984 Table 3-9 Market Shares of Financial Institutions in Japan, 1986 (%) Share of Share of Type of Institution Funds Raised Loans City Banks 19.5% 23.1% Regional Banks 13.1 12.4 Trust Banks 9.7 7.0 Long Term Credit Banks 5.2 5.1 Foreign Banks .2 1.0 Fin. Institutions for Small & Medium Businesses 15.7 14.4 Gov't Fin. Sector 27.9 33.4 Other 8.7 3.6 100% 100% Source: Federation of Bankers Associations of Japan (1987), p. 2. 192 Table 3-10 The Growing Importance of Extraordinary Profits In Foreign Rant Results in Japan. 1983-89 A B C Pre-Tax After Tax Year Net Income Net Income Extraordinary Profits C / A x 100 C / B x 100 1983 26,565 11,754 1,663 6.26% 14.15% 1984 22,374 10,344 1,217 5.44% 11.77% 1985 18,848 5,633 4,219 22.38% 74.90% 1986 31,761 12,774 1,373 4.33% 10.75% 1987 32,304 12,874 13,620 42.16% 105.79% 1988 61,425 27,856 31,961 52.03% 114.74% 1989 41,709 17,337 33,698 80.79% 194.37% (In Millions of Yen) Source: Peat Marwick, Published Financial Statements of Foreign Rank Branches in Japan, various years. Table 3-11 The World's Top 25 Banks by Extent of Geographical Diversification. 1979-861 1979 1983 1986 Rank Bank Countries2 Bank Countries2 Bank Countries2 1 Citicorp 75 Citicorp 74 Citicorp 76 2 B Nat Paris 61 B Nat Paris 65 B Nat Paris 69 3 Bank of America 57 Barclays 59 Chase 64 4 BCCI 55 Soc. Generale 57 Barclays 59 5 Barclays 54 Bank of America 57 Soc. Generale 56 6 Chase 51 B C Q 55 Credit Lyonnais 56 7 Credit Lyonnais 46 Chase 53 BCCI 55 8 Soc. Generale 44 Credit Lyonnais 49 Bank of America 53 9 B. Nova Scotia 40 B. Nova Scotia 44 B. Indosuez 47 10 Bank of Tokyo 38 Royal 41 B. Nova Scotia 46 11 Royal 34 Bank of Tokyo 40 B. Brasil 41 12 Man. Hanover 33 Man. Hanover 39 Soc. Gen de B. 41 13 Dresdner 30 B. Brasil 37 Man. Hanover 40 14 B. Brasil 29 B. Indosuez 37 Bankers Trust 40 15 Chemical 29 B. Paribas 37 B.Tokyo 40 16 First Chicago 29 American Express 34 B. Paribas 37 17 American Express 29 ABN 33 Cred. Comm. Ind. 37 18 Bankers Trust 28 Std. Chartered 33 ABN 36 19 B. Indosuez 28 Bankers Trust 32 HK Shanghai 33 20 B. Paribas 27 Dresden 31 American Express 32 21 HK Shanghai 27 Chemical 31 Dresden 32 22 A B N 25 HK Shanghai 27 B. Comm Ital 32 23 B. Comm Ital 25 First Chicago 26 Chemical 31 24 Deutsche 24 Deutsche 26 Royal 30 25 CIBC 24 Com. Illinois 26 Midland 28 Sumitomo 28 25 Wells Fargo 24 Union B. Switz 27 No. of Japanese: in Top 10 1 0 0 in Top 25 1 1 2 Notes: 1. Banks with representation in the largest number of countries among those in top 500 by assets every year from 1979 to 1986. 2. Countries where the bank has a representative office, agency, branch, subsidiary or affiliate. Source: Banker's Almanac. Rand McNally Banker's Directory. 194 Table 3-12 The Growing International Use of the Yen (figures in percent) 1980 1986 1987 Ratio of nation's Japan Exports 29.4 36.5 33.4 currency used in (¥) Imports 2.4 9.8 10.6 merchandise trade West Exports 82.3 82 — Germany Imports 42.8 52 — (DM) Currency share in US$ 66.5 62.7 35.8 international bond ¥ 1.5 10.0 14.1 issues DM 17.5 9.0 8.1 Currency share in US$ 69.0 66.6 world's foreign ¥ 4.5 6.9 — exchange reserves DM 15.6 14.8 — Source: Japan Economic Journal. May 14, 1988, p. 1. 195 Table 3-13 Foreign Rank Branch Opening Chronology: Post W W II Korea 1967: Chase Manhattan Bank, Bank of Tokyo, First National City Bank1, Mitsubishi Bank, Bank of America 1968: Standard Bank2 1972: Fuji Bank 1973: Dai Ichi Kangyo Bank 1974: Banque de l'Indochine3 1976: Banque Nationale de Paris, First National Bank of Chicago 1977: American Express Bank, Lloyds Bank, Barclays Bank, Indian Overseas Bank, Bank of Credit and Commerce International, Banque de Paris et des Pays-Bas4 1978: Grindlays Bank5, International Bank of Singapore, Bank of Nova Scotia, Continental Illinois, Morgan Guaranty6, Credit Lyonnais, European Asian Bank7, Chemical Bank, Bank of Montreal, Manufacturers Hanover Trust Company, Bankers Trust 1979: Algemene Bank Nederland, Union de Banques Arabes et Francaises (UBAF) 1981: First Interstate Bank of California, Crocker National Bank8, Marine Midland Bank, Development Bank of Singapore 1982: Sumitomo Bank, Hongkong and Shanghai Bank, Sanwa Bank, (First National) Bank of Boston, Security Pacific, Royal Bank of Canada 1983: Tokai Bank 1984: Societe Generale 1985: United Overseas Bank, Rainier National Bank', Mitsui Bank 1986: Westpac Banking Corp., Midland Bank, Yamaguchi Bank, Bank of California10 1987: National Bank of Pakistan 1988: Irving Trust, Taiyo Kobe Bank, Kyowa Bank, Saitama Bank, Daiwa Bank Notes: 1. Renamed Citibank 1976. 2. Merged and became Standard Chartered Bank 1969. 3. Merged and became Banque de PIndochine et de Suez 1975. Renamed Banque Indosuez 1982. 4. Renamed Banque Paribas 1982. 5. Bank acquired by ANZ 1984. Branch taken over by ANZ 1987. 6. Closed 1986. 7. Consortium partners bought out by Deutsche Bank 1986. 8. Bank bought and branch taken over by Wells Fargo Bank 1984. 9. Branch taken over by Security Pacific 1987. 10. Subsidiary of Mitsubishi Bank since 1984. Sources: Bank of Korea, Peat Marwick Published Balance Sheets of Foreign Bank Branches in  Korea (various years), The Bankers' Almanac and Yearbook (various years), Euromoney Top 500 listings (various years). 196 Table 3-14 Deposit Monev Bank Assets bv Tvoe of Bank. Korea. 1975-81 percent) Type of Bank 1975 1976 1977 1978 1979 1980 1981 Foreign Banks 4.1 4.2 5.4 5.7 6.2 9.2 8.3 City Banks 51.6 52.8 49.0 49.3 49.1 45.2 45.4 Local Banks 9.2 9.1 8.7 8.2 7.9 7.1 7.5 Specialized Banks 35.1 33.9 37.0 36.8 36.8 38.5 39.2 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Note: Figures may not total exactly 100% due to rounding. Source: Lee (1982), p. 6, based on Bank of Korea, Monthly Statistical Bulletin data. 197 Table 3-15 Deposit Money Rank Loans and Deposits by Type of Bank. Korea. 1985-1987 (in percent) Deposits I nans Type of Bank 1985 1986 1987 1985 1986 1987 Foreign Banks 1.2 1.4 1.3 6.0 5.9 5.8 City Banks 40.3 39.6 37.4 44.1 43.8 40.9 Local Banks 11.3 113 12.0 8.6 8.2 8.5 Specialized Banks 47.2 47.6 493 41.4 42.2 44.8 100.0 100.0 100.0 100.0 100.0 100.0 Note: Figures may not total exactly 100% due to rounding. Source: Nakarmi (1988), p. 38, based on Bank of Korea data. Table 3-16 Korean Banks in the Top 500 by Assets. 1979-88' 1979 1983 1985 1988 Bank Rank Assets Rank Assets Rank Assets Rank Assets Bank of Seoul & Trust Go. 219 5.5 144 11.7 157 18.5 112 38.9 Korea Development Bank 199 6.0 172 8.9 162 17.8 183 21.5 Korea Exchange Bank 185 6.6 141 11.9 164 17.6 157 24.4 Commercial Bank of Korea 262 4.6 236 6.7 256 10.1 206 18.9 Hanil Bank 265 4.4 237 6.6 289 8.9 227 165 Korea First Bank 270 4.3 235 6.7 296 8.5 222 17.2 Cho Hung 284 4.1 259 6.0 304 8.3 224 17.1 Korea Housing Bank - - - - 480 4.0 499 55 Small and Medium Industry Bank - - 385 3.7 - - - -Shinhan Bank2 - - - - - - 470 6.2 Industrial Bank of Korea - - - - - 400 7.8 Citizens National Bank - - - - - - 300 11.4 Notes: 1. Assets less contras in billions of U.S. dollars 2. Joint venture bank owned by South Koreans and Koreans resident in Japan Source: The Banker Annual Listings of the Top 500 Banks by Assets, 1979, 1983, 1986, Top 1000 for 1988. 199 Table 3-17 Geographical Diversification of Korean Banks. 1979-861 Bank Number of countries2 1979 1983 1986 Korea Exchange Bank 22 25 25 Hanil Bank 6 6 9 Commercial Bank of Korea 5 6 6 Cho Hung 5 6 5 Korea First Bank 4 5 7 Bank of Seoul and Trust Co. 0 0 6 Korea Development Bank 0 0 7 Notes: 1. Includes banks which were in the Top 500 by assets every year from 1979 to 1986. 2. Number of countries where the bank has a representative office, agency, branch, subsidiary or affiliate. Source: Banker's Almanac, various years; Rand McNally Banker's Directory. 200 Table 3-18 The. Importance of Head Office Transfers as a Source of Funding  for Foreign Branches in Korea. 1975-19881 % 1975 1976 1977 1978 1979 1980 1981 1984 1988 48.9 51.5 69.4 71.7 75.3 77.6 73.4 71.0 563 Note: 1. Due to head office and affiliates as a percentage of total assets less contras (i.e., guarantees and acceptances). Source: 1975-1982 from Lee (1982), p. 5. 1984 and 1988 from Kim (1989)). 201 Table 3-19 Foreign Banks' Market Share bv Type of Banking Business. Korea. 1977-19881 (as of the end of each period - %) Line of Business 1977 80 83 84 85 86 87 88 Deposits 1.1 1.5 2.1 2.3 2.0 1.7 15 1.0 won 1.1 1.3 13 1.4 1.3 1.5 13 0.9 foreign currency 1.3 3.7 225 21.3 15.4 5.8 3.2 1.4 Loans 7.8 12.3 10.9 11.6 11.4 10.9 10.2 8.5 won 4.4 5.0 5.6 6.1 5.9 5.9 5.8 5.6 foreign currency 39.9 46.3 51.9 60.9 67.42 63.3 44.6 34.1 Guarantees 1.7 5.4 11.2 13.8 16.8 18.2 22.8 25.3 Total assets 4.1 7.8 9.3 9.9 10.6 10.8 10.5 9.4 Notes: 1. Foreign banks' share among all deposit money banks in Korea. 2. In 1985 these foreign currency loans accounted for 58% of the total loans advanced by foreign banks (Kim, 1989, p. 5). Source: The Bank of Korea, Monthly Statistical Bulletin, cited in Kim (1989), p. 4. 202 Table 3-20 Profitability of the Korean Banking Sector. 1968-1982 Return on Assets (percent) BOK Subsidies Foreign Bank Domestic to Domestic Banks Branches Banks (in billions of won) 1968 1.2 0.3 1.1 1969 1.6 0.5 1.2 1970 2.1 0.2 3.4 1971 2.3 0.2 4.5 1972 1.5 0.6 10.3 1973 15 1.5 12.8 1974 2.2 1.5 6.7 1975 1.2 1.3 20.9 1976 1.0 1.4 3.5 1977 0.8 0.2 3.4 1978 1.6 0.5 16.1 1979 1.4 0.4 41.1 1980 1.3 0.4 1.1 1981 1.3 0.4 65.5 1982 1.3 0.0 54.2 Sources: The Bank of Korea, Economic Statistics Yearbook and Annual Report, various issues, cited in Kwack and Chung (1986), p. 131. 203 Table 3-21 Profitability of Foreign Ranks in Korea. 1983-88 (A) Aggregate Number Net Income Year of Banks Net Income1 Assets' /Assets(%) 1983 40 53.078 6,616.8 .80% 1984 43 65.755 7,705.7 .85% 1985 45 90.224 9,369.4 .96% 1986 472 81.210 10,411.0 .78% 1987 483 93.103 9,634.6 .97% 1988 46 129.615 12,583.3 1.03% (B) Distribution 1983 1984 1985 1986 1987 1988 Aggregate ROA .80% .85% .96% .78% .97% 1.03% (as above) Median ROA .80% .91% .88% .86% 1.03% 1.03% High 1.70% 2.09% 2.55% 1.57% 2.12%" 2.99% Low .002% -1.02% .05% -.22% -.02% .06% Number of banks reporting: 39 43 45 46 39 46 of which ROA = 1% or above 11 16 17 12 19 24 .5% to .99% 20 21 20 25 14 11 .25% to .49% 4 1 6 4 3 8 0% to .24% 4 3 2 2 2 3 Losses 0 2 0 3 1 0 Notes: 1. Billions of Won 2. Figures include only 46 banks (one new bank did not report) 3. Figures include only 39 banks (Japanese did not report) 4. Excluding Rainier, which had an unusually high ROA of 13.06% as its assets had run down prior to closing. Source: San Tong/Peat Marwick, Published Balance Sheets of Foreign Bank Branches in Korea. 1983 to 1986. Table 3-22 Trends in Korean Overseas Investment (In Millions of U.S.J) 1968-82 1983 1984 1985 1968-85 Sub-total 1986 1987(1-6) Total No. of No. of No. of No. of No. of Share No. of No. of No. of Share By Industry Cases Amount Cases Amount Cases Amount Cases Amount Cases Amount (%) Cases Amount Cases Amount Cases Amount (%) Mining 9 103.0 1 46.0 1 19.7 2 4.0 13 172.7 36.3 - 713 -1 110.7 12 354.9 39.9 Forestry 9 37.1 2 15.0 - 5.6 - 3.2 11 60.9 12.8 -1 -5.4 -1 -10.8 9 54.7 6.2 Fishery 25 9.2 5 0.1 -3 0.0 -2 -3.1 25 - 6.2 1.3 1 3.7 - 0.7 26 10.6 1.2 Manufacturing 36 33.4 14 25.5 10 13.3 9 19.5 69 91.7 19.2 18 68.7 11 137.2 98 297.6 33.9 Construction 33 30.4 8 2.6 5 1.9 -1 1.1 45 36.0 7.6 - -1.0 - -5.3 45 29.7 3.3 Transportation & Storage 17 2.7 3 0.0 - -0.2 -1 -0.1 19 2.4 05 - 0.0 -1 0.0 18 2.4 0.3 Trade 194 36.6 14 11.4 10 7.7 2 9.2 220 64.9 13.6 7 12.0 11 11.1 238 88.0 95 Real Estate 9 20.1 - - - - 1 2.8 10 22.9 4.8 2 2.9 - - 12 25.8 2.9 Others 20 16.8 2 -3.9 8 10.4 1 -5.1 31 18.2 3.9 5 4.7 -1 1.8 35 24.7 2.8 Total 352 289.5 49 96.8 31 58.4 11 31.5 443 476.2 100.0 32 157.1 19 255.4 494 888.7 100.0 By Region South-East Asia 105 66.1 19 25.1 3 10.4 11 16.9 138 118 5 24.6 11 1.7 -5 124.6 144 244.8 275 Middle East 32 25.8 3 1.9 3 4.2 -2 9.4 36 41.3 8.7 -1 72.7 -1 37.3 34 151.3 17.0 North America 115 78.5 20 41.5 21 24.6 -1 8.7 155 153.3 32.2 19 76.1 15 133.3 189 362.7 40.8 Latin America 20 39.0 6 11.6 3 5.6 2 2.8 31 59.0 12.4 - 2.3 5 -455 36 15.8 1.8 Europe 47 7.4 -3 1.9 -1 1.3 -1 0.7 42 11.0 2.3 2 5.4 4 5.4 48 21.8 25 Africa 17 18.5 3 -0.7 1 1.0 - -6.6 21 12.2 2.6 -2 -0.7 1 0.2 20 11.7 1.3 Oceania 16 54.2 1 15.5 1 11.6 2 -0.4 20 80.9 16.9 3 -0.4 - 0.0 23 80.6 9.1 Notes: 1. The sign (-) represents capital withdrawal. 2. These figures are based on actual investments. Source: Kwag (1987), based on Ministry of Finance data. to O 205 Table 3-23 Japan's Private Foreign Capital Stock. 1960-84 (US $ mV Inward Direct2 Investment Outward Direct Investment Book value of capital stock 1960 88 529 1965 270 1394 1970 594 3,576 1975 1,497 15,941 1976 1,693 19,403 1977 1,917 22,209 1978 2,153 26,807 1979 2,677 31,802 1980 2,976 36,495 1981 3,408 45,403 1982 4,157 53,131 1983 4,974 61,276 1984 N A . 71,431 Notes: 1. Data refer to cumulative investment flows from Fiscal Year ending March 1951 onwards. Each year refers to the situation in March of the succeeding year. 2. The totals for inward direct investment include investment in Japan by foreign affiliates of Japanese parent companies. Source: Dunning (1987), based on data from: Ministry of International Trade and Industry, Gaishikei Kigvo no Doko. various years; Ministry of Finance, Zaisei Kinvu Tokei Geppo. various issues. Table 3-24 Stock of Foreign Direct Investment in Japan by Country. 1985-88 1985' 19872 19882 Country Firms Amount3 Cases Amount3 Cases Amount3 U.S. 2329 3.495 5574 3.407 6245 4.010 U.K 409 360 1913 353 2281 .402 Switzerland 266 355 1248 .447 1555 .565 W. Germany 315 .238 1186 .297 1422 347 Netherlands 129 .164 763 .182 1031 .259 France 252 .133 1199 .152 1376 .164 Canada 76 .124 373 .126 490 .127 Hong Kong n.a. n.a. 2801 .288 3170 .317 Panama - .036 n.a. n.a. n.a. n.a. Belgium - .007 n.a. n.a. n.a. n.a. Foreign Affiliates in Japan" n.a. n.a. 2276 1.121 2647 1.347 Other - 1761 5879 .634 6907 .923 6286 6.653 23,212 7.007 27,124 8.460 Notes: 1. End of year. 2. March 31. 3. billions of U.S. dollars 4. i.e., investment in Japan by overseas subsidiaries of Japanese companies Source: Japan: An International Comparison. 1986, 1987, 1988, 1989. 207 Table 3-25 Foreign Investment in Korea by Year (in millions of U.S. dollars) Year No. of Projects Flow Amount 1962-66 39 47.4 1967-71 349 218.6 1972-76 851 879.4 1977 54 83.6 1978 51 149.4 1979 55 191.3 1980 40 143.1 1981 44 153.2 1982 56 189.0 1983 75 269.4 1984 104 422.3 1985 127 532.0 1986 203 353.7 1987 (Jan-June) 164 423.6 Total Stock 2,212 4,056.1 Note: Approval basis. In most cases the actual amount invested was substantially less than that approved. Source: Kim (1987) based on Ministry of Finance data. 208 Table 3-26 Foreign Investment in Korea by Country (Approval Basis') (Unit: US $ million) 1962 - 66 67- 71 72 - 76 77- 81 82 - 86 1st Half 1987 Total No. of No. of No. of No. of No. of No. of No. of Projects Amount Projects Amount Projects Amount Projects Amount Projects Amount Projects Amount Projects Amount Japan 5 83 (17.5) 241 89.7 (41.0) 739 627.1 (7U) 132 300.9 (41.8) 276 875.2 (493) 100 190.2 (44.9) 1,493 2,091.4 (51.6) U.S.A. 25 25.0 (52.7) 84 953 (43.6) 78 135.0 (15.4) 67 235.7 (32.7) 168 581.6 (32.9) 34 883 (20.9) 456 1;161.1 (28.6) Europe 4 10.8 (22.8) 10 9.9 (43) 24 38.8 (4.4) 38 95.3 (13.2) 86 1915 (10.8) 15 84.0 (19.8) 177 4303 (10.6) (UK.) 1 103 (22.2) 2 0.2 (0.1) 1 2.7 (03) 7 17.7 (23) 13 34.1 (1.9) 4 44.1 (10.4) 28 109.3 (2.7) (W. Germany) 2 0.2 (0.4) 5 25 (1.1) 13 9.2 (1.0) 10 24.6 (3.4) 21 27.1 (13) 3 0.7 (0.2) 54 643 (1.6) (Switzerland) 0 0 0 0 2 0.2 10 30.9 (43) 14 48.9 (2.8) 2 24.8 (5.9) 28 104.8 (2.6) Hongkong 3 2.8 . (5.9) 6 3.0 (1.4) 9 135 (1-5) 5 42.1 (5.8) 20 643 (3.7) 6 41.9 (9.9) 49 167.8 (4.1) Others 2 0.5 (1.1) 8 20.7 1 65.0 (7.4) 2 46.6 (6-5) 15 53.7 (3.0) 9 19.0 (43) 37 2053 (5.1) Total 39 47.4 (100.0) 349 218.6 (100.0) 851 879.4 (100.0) 244 720.6 (100.0) 565 1,7665 (100.0) 164 423.6 (100.0) 2,212 4,056.1 (100.0) Note: Source: The figures in the parentheses denote the ratio to the total. Kim (1987), based on Ministry of Finance data. Table 3-27 Stock of Foreign Direct Invesfmftnt in Korea by Industry. 1986* Sector Percentage of Total Hotels and Tourism 28.5% Electrical and Electronics 15.1 Chemicals 13.6 Machinery 123 Banking 43 Construction and Services 4.0 Foodstuffs 3.8 Medical 2.9 Textiles 2.6 Metal 2.6 Transportation Equipment 2.2 Fertilizer 1.4 Oil 1.2 Ceramics 1.1 Forwarding and Warehousing 1.1 Other 33 100% Note: 1. Source: Approval basis 1962-1986. Korea Annual. 1987, p. 197. 210 Table 3-28 Korea's Foreign Debt Year Amount 1972 US $ 3.550 Billion 1973 4.696 " 1974 5.835 " 1975 8.214 " 1976 10.169 " 1977 11.857 " 1978 13.608 " 1979 20.410 " 1980 27.315 " 1981 32.480 " 1982 40.443 " 1984 43.102 " 1985 46.700 " Source: Handbook of the Korean Economy. 1980, table 74, cited in Tony Michell (1988) From a Developing  to a Newly Industrialized Country: The Republic of Korea. 1961-82 (Geneva, I.L.O), p. 166 (1972-78); Business Korea Handbook. 1986, p. 11-46 (1979-85). < Table 4-1 Model I (Survival Timet Results Branches Rep Offices Independent Variable Japan Korea Japan Korea ASSETS .0007" .0003" .0004" .0003" (8.22) (331) (5.56) (3.55) COUNTRIES .0170 .0897" .0555" .0955" (1.005) (4.42) (2.92) (5.12) CAPRATIO 20.46" 3.78 10.20" 6.53 (3.64) (.43) (3.47) (1.02) COMMPCT .0092' .1626" .0513 .1719" (1.99) (2.54) (1.90) (3.60) EUROBONDS .7552 .7105 -1.52 1.27 (.3413) (.22) (-.56) (.50) DISTANCE -.0008" -.0003" -.0003 -.0004" (-3.47) (-3.05) (-1.81) (-5.57) TRADE -.0002 -.0025 -.0002' -.0013 (-1.65) (-1.58) (-2.07) (-1.05) OPEN 2.58" 1.04 n.a. n.a. (3.20) (1.72) N Chi-squared P-Value 215 246 201 246 180.65 305.96 130.12 295.61 .0000 .0000 .0000 .0000 * Significant at the .05 level. ** Significant at the .01 level. Note: 1. Numbers in parentheses = coefficient/standard error ("t-statistic") 2. Period of analysis: 1/1/67 - 3/31/87 (end of 1986 fiscal year) Source: See Section 4.1. 212 Table 4-2 Model II (Multinomial Logit') Results Japan Korea Independent Variable Branches Rep Offices Branches Rep Offices ASSETS .00006" .00004 .00005' .000007 (2.36) (1.63) (2.40) (.37) COUNTRIES .2732" .1915" 3890" .2161" (4.92) (3.86) (4.76) (3.66) CAPRATIO -7.27 15.13 -119.25" -74.11 (-.38) (.94) (-2.58) (-1.95) FINPCT .5281" .2725 3.8750" 1.075 (3.25) (1.94) (3.13) (1.35) EXPERTISE 4491.0 -3445.1 10853.0 5383.7 (1.18) (-1.07) (.88) (.48) IMPORTS .0002 -.00004 .0015 -.00005 (.88) (-.19) (1.95) (-.07) FDI -.000008 -.000002 -.0524 -.007 (-1.73) (-.44) (-3.07)" (-.67) RENT .0021 .0011 .0020 .0015 (1.74) (.92) (1.48) (.77) DISTANCE -.0015" -.0008" -.0056" -.0008 (-3.59) (-2.36) (-3.17) (-.71) CONSTANT -1.83 -1.98 -10.78' -8.25 (-.85) (-1.09) (-2.09) (-1.93) N 204 200 Likelihood Ratio Test Statistic (Prob) 193.88 (<.01) 196.14 (<.01) Percent Correctly Predicted 80.88% 92.50% * significant at the .05 level ** significant at the .01 level Note: 1. Numbers in parentheses = coefficient/standard error ("t-statistic") 2. Results are for presence in 1986 as a function of the 1983 values of the independent variables (see Section 3.3). 3. 'Likelihood Ratio Test Statistic should be compared to a chi-squared distribution with 18 degrees of freedom (critical value for p = .01 is 34.805). 4. The largest category (no branch or rep. office) comprised 56.37% (115 out of 204) of the sample in Japan and 73.5% (147 out of 200) in Korea. Source: See Section 4.2. 213 Table 4-3 Model II fMnlrinnmial Logit) Results: Average Elasticities Independent Variable Japan Branches Rep Offices Korea Branches Rep Offices ASSETS 37" -0.5 .70" -.48 COUNTRIES 53" -.29" 1.16" -.46" CAPRATIO -32 .74 -3.95" -2.04 FINPCT 233" .50 22.52" 1.67 EXPERTISE .02 -.13 .07 -.03 IMPORTS 2.59 -1.50 4.76 -1.26 FDI -4.79 .33 -13.80" -.24 RENT 3.25 .80 7.80 2.77 DISTANCE -4.94" -1.42" -16.01" 1.25 Source: See Section 4.2. 214 Table 44 1979 Cluster Analysis: Japan Cluster #1 Ouster #4 Ouster #5 Banco do Brasil Korea Exchange Bank Bank Negara Indonesia Korea First Bank Ouster #2 Credit Suisse Midland Bank BNP Standard Chartered First Chicago Societe Generale ABN Banca Com. Italiana Amro Bank Credit Lyonnais Banque Paribas Nat'l Bank of Detroit Generale Bank United Overseas Bank Overseas Chinese Bank UBAF Banco do Estado de Sao Paolo Overseas Union Bank Int'l Comm Bank of China Ouster #3 Bank of America Chase Manhattan Hanil Bank Bank of India Citibank Barclays Bank National Westminster Morgan Guaranty Deutsche Bank Union Bank of Switz. Swiss Bank Corp. Lloyds Bank Manufacturers Hanover Hongkong & Shanghai Chemical Bank First Interstate Bankers Trust Dresdner Bank Westdeutsche Landesbank Commerzbank Mellon Bank Wells Fargo Bank of Boston Bayerische Vereinsbank American Express Bank Irving Trust Devel. Bank of Singapore Banque Indosuez Bank Bumiputra Rainier Nat'l Bank Bangkok Bank Bank of California Marine Midland Seattle First Nat'l Bank Mercantile Bank Security Pacific Continental Illinois Nat'l Bank of Pakistan Grindlays Bank Crocker Nat'l Bank Source: See Section 4.3. 215 Table 4-5 1983 Cluster Analysis: Japan Ouster #1 Cluster #3 Ouster #5 (cont'd} Bankers Trust Korea Exchange ABN Wells Fargo Korea First Banca Com Italiana Marine Midland Hanil Amro Royal Bank American Express Deutsche Bank of Montreal Seattle First Nat'l UBS Toronto Dominion Irving Dresdner CIBC Bank of America WD LB Midland Chase Commerzbank Barclays Bay. Vereins BNP Ouster #4 BNS Societe Generale Nat West. Credit Lyonnais Banco do Brasil Cho Hung UBAF B. Est. Sao Paolo United Overseas Cr. Comm de France Overseas Chinese Generale Bank Ouster #5 Hongkong & Shanghai Swiss Bank Corp. DBS Credito Italiano First Chicago Banque Indosuez Banco Hispano-Americano Nat'l Bk of Detroit Banque Paribas Comm Bk of Korea Chemical Bangkok Overseas Union First Interstate Int. Comm Bank of China Mellon Ouster #6 State Bank of India Bank of Boston Nat'l Bank of Pakistan Rainier Crocker Bank Negara Indonesia Bank of California Standard Chartered Continental Illinois Lloyds Cluster #2 Manufacturers Hanover Bank of India Citibank B. Bumiputra Grindlays Morgan Guaranty Security Pacific Credit Suisse Source: See Section 4.3. 216 Table 4-6 1986 Cluster Analysis: Japan Cluster #1 Cluster #1 Cconfdt Ouster #4 Nat'l Australia UBS Toronto Dominion Ned. Middenstand Hongkong B. do Brasil BHF Chemical B. Est. Sao Paolo Bank of Hawaii First Interstate Royal Bank Dresdner Ouster #5 Bank of Montreal WDLB Marine Midland Commerz B. of Seoul BNP Mellon Shinhan Societe Generale Bank of Boston Cr. Italiano Credit Lyonnais Bayer. Vereins CIBC Generale Bank DBS Cr. Comm de France UBAF Indosuez B. Hispano-Americano Overseas Union Rainier Comm. Bk of Korea Barclays Bank of California B. Negara Indonesia Swiss Bank Corp. Cont. Illinois Korea Exchange Bankers Trust Standard Chartered Korea First Wells Fargo Chase Bank of America Ouster #2 Hanil Irving Trust Cho Hung BNS ANZ . Paribas Credit Suisse State Bank of India Citibank First Chicago N. Bank of Pakistan Morgan ABN Security Pacific B. Comm. Italiaha Manufacturers Hanover Amro Bank of India NB Detroit Lloyds United Overseas B. Bumiputra Overseas Chinese Natwest Ouster #3 Deutsche Westpac Int'I Comm Bk of China Bangkok Source: See Section 4.3. 217 Table 4-7 1989 Cluster Analysis: Japan Cluster #1 Ouster #3 Ouster #5 Chemical Citibank Lloyds Paribas Barclays ANZ Int. Comm Bk of China Morgan Irving Bank of China Bank of America Banco Santander BNP NB Pakistan Cluster #2 CIBC First Chicago Cluster #6 Natwest B. Comm. Italiana Deutsche Credit Lyonnais UBS Swiss Bank Corp Korea Exchange Chase Manufacturers Hanover B. Bumiputra Midland Hongkong & Shanghai Cr. Comm. de France First Interstate Credit Suisse B. Hisp.-Americano Bankers Trust Royal Bank State Bank of India Security Pacific Dresdner Bangkok B. of Montreal Standard Chartered UBAF Mellon Soc. Generale Comm. Bk of Korea Westpac BNS BHF B. of Boston Commerz WDLB 1st. Bancario Sao Paolo ABN B. Negara Indonesia Republic Bank NY Amro Korea First NB of Canada N. Australia Bank of Seoul Wells Fargo Cho Hung Commonwealth Bank of India Bayer. Vereins. Shinhan NB Detroit DBS Ouster #4 Generale Ned. Middenstand B. do Brasil Indosuez Toronto Dominion United Overseas Cr. Italiano Overseas Chinese BCCI Overseas Union B. Est. Sao Paolo Continental BNZ Bank of Hawaii Bank of California Source: See Section 4.3. 218 Table 4-8 Variable Means hy Ouster for Japan r 1979-1989 Ouster Means - 1979 Ouster DEP SEC GTEE HO LOANS 1 2.57900 -036172 -0.44302 -1.76206 -0.32541 2 -0.54446 0.00498 -0.44747 0.40364 -0.85410 3 1.34409 0.18509 2.07696 -1.48616 -0.32595 4 -0.09469 0.09329 -0.30498 0.26221 0.77240 5 -0.48248 -0.45604 2.28411 -0.56092 -1.02223 Ouster Means -1983 Ouster DEP SEC GTEE HO LOANS 1 -0.46277 -0.39931 -0.26165 0.52531 -0.86008 2 • 0.01531 2.39964 2.94616 -0.97063 -0.70355 3 1.71107 -0.50708 -0.22573 -0.73210 0.98267 4 -0.43189 -0.45039 -0.66552 -3.67336 -0.72534 5 -0.22102 0.40453 -0.30351 0.18834 0.59727 6 1.06478 -0.64066 2.64732 -0.69789 -0.69486 Ouster Means -1986 Ouster DEP SEC GTEE HO LOANS 1 -0.46349 -0.26203 -0.25724 0.48036 0.34378 2 0.21199 0.05661 2.57211 -0.17203 -0.78923 3 -0.44329 3.47208 -0.43218 -0.06015 -0.41649 4 -0.27923 -0.74841 -0.27311 -3.03782 -1.06743 5 1.36200 0.21433 -0.41424 -0.71414 -0.31551 Ouster Means -1989 Ouster DEP SEC GTEE HO LOANS 1 -0.24333 3.42202 -0.50502 -0.07890 -1.11437 2 -0.53962 -0.27523 -0.15122 0.53470 1.04367 3 0.52052 0.05261 -0.22413 -0.43176 -0.21049 4 1.96140 -0.57851 -0.38147 -2.13773 -1.10741 5 0.06613 -0.48301 3.43644 -0.31954 -0.54309 6 -0.69310 -0.09140 -0.20466 0.80457 -0.84432 Source: See Section 4.3. Tabic 4-9 Ten Largest Foreign Bank Branches in Japan by Total Assets. 1979-89 1979 Assets' Market Share2 1983 Assets Market Share 1986 Assets Market Share 1989 Assets Market Share t. Citibank 953.4 12.26% Citibank 1431.0 9.70% Citibank 1078.1 6.96% BNP 1140.9 5.22% 2. B. America 808.8 10.40 Soc Generale 1173.6 7.96 BNP 1009.1 6.51 Barclays 1122.7 5.14 3. Chase 670.4 8.62 BNP 839.7 5.69 Soc Generale 936.3 6.04 Soc. Generale 1036.7 4.74 4. Morgan 295.2 3.79 B. America 832.0 5.64 Credit Lyonnais 800.2 5.16 Credit Lyonnais 1023.0 4.68 5. Deutsche 268.8 3.46 Chase 742.0 5.03 B. Indosuez 564.8 3.64 Citibank 961.8 4.40 6. Cont. Illinois 252.2 3.24 Credit Lyonnais 679.7 4.61 Chase 562.0 3.63 Bankers Trust 883.7 4.04 7. BNP 242.6 3.12 B. Indosuez 580.0 3.93 B. America 555.0 3.58 WDLB 763.5 3.49 8. Soc Generale 204.8 2.63 Morgan 467.9. 3.17 Morgan 468.5 3.02 B. Indosuez 675.3 3.09 9. Credit Lyonnais 203.7 2.62 UBAF 342.7 2.32 Paribas 445.6 2.87 UB Switz. 641.2 2.93 10. Man. Hanover 203.4 2.62 Deutsche 342.2 2.32 Chemical 431.3 2.78 UBAF 544.3 2.49 Notes: 1. Billions of yen. 2. As % of total assets of foreign bank branches only. Source: Peat Marwick, Published Financial Statements of Foreign Bank Branches in Japan, various years. Table 4-10 The Twenty Foreign Banks in Japan with the Lowest Branch Assets per Employee. 1986 Bank Country Assets per Employee1 1. United Overseas Bank Singapore 415.702 2. Overseas Chinese Bank Singapore 509.25 3. International Commercial Bank of China Taiwan 575.16 4. Bank of Boston USA 612.64 5. Commercial Bank of Korea Korea 681.10 6. Cho Hung Bank Korea 699.72 7. Security Pacific Bank USA 726.12 8. Shinhan Bank Korea 77933 9. Hanil Bank Korea 813.13 10. Hongkong and Shanghai Banking Corp. Hong Kong 815.59 11. Bank of Seoul Korea 817.33 12. Westpac Australia 869.92 13. Bangkok Bank Thailand 871.15 14. Standard Chartered U.K. 88130 15. State Bank of India India 914.38 16. Berliner Handels-und Frankfurter Bank W. Germany 971.68 17. Mellon Bank USA 981.39 18. Irving Trust USA 992.82 19. Bank of India India 103638 20. Nederlandsche Middenstandsbank Netherlands 1061.60 Median of 74 banks 1782.65 Highest of 743 108133 Notes: 1. Millions of yen. 2. Employment figures were not available for The National Bank of Pakistan. 3. Top 3 are all over 10,000 (Credit Lyonnais, Banque Nationale de Paris and Societe Generale). Sources: Peat Marwick Minato, Published Balance Sheets of Foreign Banks in Japan. 1986; Federation of Bankers' Associations of Japan. 221 Table 4-11 Most Profitable Foreign Ranks in Japan by R O A . 1983-19891 1983 19862 1989 1. Nat'l Bk of Pakistan 5.90% Nat'l Bk of Pakistan 5.23% Nat'l Bk of Pakistan 5.44% 2. Korea First Bank 2.12 First Interstate 3.42 Korea First Bank .97 3. Hanil Bank 1.42 Cho Hung 2.69 Hanil .89 4. Bangkok Bank 1.39 Korea First 1.83 ANZ .69 5. Wells Fargo 1.13 Comm Bk of Korea 151 Chemical .64 6. Man. Hanover 1.11 First Chicago 1.12 Morgan .61 7. State Bk of India 1.07 State Bk of India 1.06 Nat'l Australia .52 8. Int'l Comm Bk of China 1.04 Irving Trust .98 Cho Hung SI 9. Bank of India 1.00 Int Comm Bk of China .90 Bangkok SO 10. Cho Hung .83 Hanil .87 Toronto Dominion ,463 Notes: 1. Defined as ordinary income/total assets of branch(es) in Japan. 2. Excludes Marine Midland, which was about to close. 3. Korea Exchange Bank and Bank of Seoul were #11 and #12. Source: Peat Marwick, Published Balance Sheets of Foreign Bank Branches in Japan, various years. 222 Table 4-12 Characteristics of Korean Banks in Japan 1983 Rank by ROA1 1986 Rank by assets 1989 per employee (1986) Bank of Seoul # 30 # 12 # 63 Cho Hung Bank 10 4 8 68 Comm Bk. of Korea 722 6 21 69 Hanil Bank 3 11 3 65 Korea Exchange Bank 32 36 11 48 Korea First Bank 2 5 2 50 Shinhan - 753 64 66 Out of 73 77~ 83~ 74" Notes: 1. Defined as ordinary income/total assets 2. Newly established in 1982. 3. Newly established in 1986. Sources: Peat Marwick, Published Financial Statements of Foreign Bank Branches in Japan, various years; Ministry of Finance data. 223 Table 4-13 Foreign Bank Branches in Japan which •were Net Suppliers of Funds to Their Head Offices (% of total assets) 1979 Banco do Brasil 14.8% Hanil Bank 11.0% Korea Exchange Bank 10.4% 1983 1986 1989 Banco do Brasil 64.2% Banco do Brasil 68.4% Banco do Brasil 72.9% Banco do Estado Banco do Estado Banco do Estado de Sao Paolo 48.7% de Sao Paolo 50.6% de Sao Paolo 45.4% Toronto Dominion 29.8% Toronto Dominion 44.0% Bank of Seoul 20.3% Bank of New Zealand 39.0% Korea Exchange Bank 18.4% Bank of China 303% Banque Paribas 15.2% BCCI 30.2% Korea First Bank ' .4% State Bank of India 27.4% CIBC 23.9% Korea Exchange Bank 6.7% National Bank of Pakistan 6.2% Bank of Seoul 60% Cho Hung 4.8% Royal 4.8% Credit Comm. de France 2.9% UBAF 1:1% Credito Italiano 2% Source: Peat Marwick, Published Financial Statements of Foreign Bank Branches in Japan, various years. Table 4-14 1983 Ouster Analysis: Korea Ouster #1 DBS Int'l Bank of Singapore Indian Overseas Bank Sumitomo Security Pacific Ouster #2 Ouster #3 First Interstate Morgan Bank of America Crocker BNP Bank of Montreal Paribas ABN Indosuez UBAF Grindlays Mitsubishi Citibank BNS Cont. Illinois Man. Hanover Marine Midland Bank of Tokyo American Express Fuji BCCI Barclays Credit Lyonnais Dai-ichi Kangyo Chase Sanwa Standard Chartered Bankers Trust Hongkong First Chicago Bank of Boston Lloyds Chemical Royal Bank Deutsche Source: See Section 4.3. Table 4-15 1986 Cluster Analysis: Korea Ouster #1 Clnster #2 Cluster #3 DBS Man. Hanover UBAF Bank of America Grindlays Sumitomo Int'l Bank of Singapore Rainier United Overseas First Interstate Bankers Trust Bank of Montreal Indian Overseas Chemical Sanwa Westpac BNP Bank of Nova Scotia Bank of California Chase Barclays Lloyds ABN Wells Fargo Tokai Citibank Dai-ichi Kangyo First Chicago Fuji Cont. Illinois Mitsubishi Indosuez Mitsui Hongkong Security Pacific Bank of Boston BCCI Bank of Tokyo Paribas Standard Chartered American Express Credit Lyonnais Deutsche Midland Societe Generale Royal Bank Source: See Section 4.3. 226 Table 4-16 1988 Cluster Analysis: Korea Cluster #1 Cluster #2 Ouster #4 Wells Fargo Bankers Trust Bank of California First Interstate Chase Int'l Bank of Singapore UBAF DBS United Overseas Cluster #3 ABN Int'l Bank of Singapore First Chicago Bank of Montreal Citibank Deutsche Chemical Man. Hanover Bank of America Lloyds BNP Bank of Boston Sanwa American Express Barclays Westpac Mitsui Indosuez NB Pakistan Security Pacific Tokai Standard Chartered BNS BCCI Bank of Tokyo Hongkong Fuji Royal Bank Mitsubishi Societe Generale Dai-ichi Kangyo Paribas Yamaguchi Credit Lyonnais Sumitomo Irving ANZ Source: See Section 4.3. 227 Table 4-17 Variable Means bv Ouster Korea Ouster Means - 1983 Ouster DEP 1 2 3 0.03960 0.07468 -0.14162 SEC 1.99411 -0.48260 0.04974 GTEE -0.98707 0.76150 -0.90904 HO 0.70158 -0.71340 0.93746 LOAN 0.04049 -0.69459 1.15988 Ouster Means -1986 Ouster DEP 0.45244 -0.05490 -0.13382 SEC 1.90168 -0.38501 -0.25396 GTEE -0.83030 0.73959 -1.03210 HO 0.08851 -0.60571 1.16375 LOAN 0.23881 -0.65784 1.18709 Ouster Means - 1988 Ouster DEP 1 2 3 4 -0.22942 -0.92598 -0.20912 1.70412 SEC -0.29243 3.17940 -0.22546 0.60251 GTEE -0.68032 0.49459 1.00367 -0.62747 HO 0.63063 -1.40256 -0.70758 0.31815 LOAN 0.63294 -1.45091 -0.74382 0.37584 Source: See Section 4.3. Table 4-18 Top 10 Foreign Bants in Korea by Reliance on Loans. 1983-88* 1983 1986 1988 1. Fuji Bank 89.0% 1. Mitsubishi Bank 92.3% 1. Mitsubishi Bank 90.7% 2. Mitsubishi Bank 79.4 2. Fuji Bank 87.7 2. Yamaguchi Bank 90.2 3. Bank of Montreal 72.6 3. Sumitomo Bank 79.8 3. Dai-ichi Kangyo 81.9 4. Bank of Tokyo 70.0 4. Milsui Bank 73.5 4. United Overseas Bank 77.3 5. Sanwa Bank 69.2 5. Barclays Bank 72.1 5. Overseas B. of Singapore 73.3 6. Crocker Nat'l Bank 69.1 6. Bank of Montreal 70.7 6. Bank of Montreal 71.1 7. Dai-ichi Kangyo Bank 68.3 7. Tokai Bank 69.7 7. Tokai Bank 70.7 8. UBAF 65.7 8. Bank of Nova Scotia 67.9 8. Sumitomo Bank 68.4 9. Bank of Nova Scotia 64.8 9. United Overseas Bank 67.5 9. Mitsui Bank 67.3 10. Barclays Bank 64.5 10. ABN 65.5 10. ABN 65.5 Median 46.1% Median 51.7% Median 43.5% Lowest: BCCI 7.6% Lowest: BCCI 11.4% Lowest: BCCI 11.5% Note: 1. i.e., Loans as a percentage of total assets. Source: San Tong/Peat Marwick, Published Balance Sheets of Foreign Bank Branches in Korea, various years. Tabic 4-19 Top 10 Foreign Banks in Korea by Reliance on Head Office Funding. 1983-19881 1983 1986 1988 1. Fuji Bank 89.3% 1. Mitsubishi Bank 89.1% 1. Dai-ichi Kangyo Bank 79.2% 2. Mitsubishi Bank 84.4 2. Fuji Bank 85.9 2. Mitsubishi Bank 77.3 3. Sumitomo Bank 82.1 3. Sumitomo Bank 79.9 3. Yamaguchi Bank 70.3 4. Bank of Tokyo 73.7 4. Bank of Montreal 71.5 4. Sumitomo Bank 66.9 5. Bank of Montreal 70.8 5. Tokai Bank 70.1 5. Tokai Bank 62.3 6. Int'l Bank of Singapore 67.5 6. United Overseas Bank 69.0 6. United Overseas Bank 51.4 7. Sanwa Bank 67.4 7. Bank of Nova Scotia 65.3 7. ABN 50.7 8. UBAF 66.8 8. Barclays 64.9 8. Chemical 49.4 9. Bank of Nova Scotia 66.6 9. UBAF 63.4 9. Bank of Tokyo 49.4 10. Crocker Nat'l Bank 66.0 10. Dai-ichi Kangyo Bank 63.4 10. Bank of Montreal 48.9 Median 50.8% Median 44.6% Median 33.6% Lowest: BCCI -19.8% Lowest: BCCI 0.7% Lowest: BCCI -1.4% Note: 1. (Due to Head Office - Due from Head Office)/Total Assets. Source: San Tong/Peat Marwick, Published Balance Sheets of Foreign Bank Branches in Korea, various years. 230 Table 4-20 Top 10 Foreign Ranks in Korea bv Assets per Employee*. 1986 Bank Assets/Employee 1. Fuji Bank Wll.633.1 2. Mitsubishi Bank 9,404.5 3. Tokai Bank 8,878.6 4. Credit Lyonnais 8,749.2 5. Paribas 8,030.9 6. United Overseas 6,606.0 7. Banque Nationale de Paris 6,365.3 8. American Express 6,164.2 9. Sanwa Bank 6,063.7 10. Bank of Tokyo 5,440.3 Note: 1. in millions of won Source: San Tong/Peat Marwick. Published Balance Sheets of Foreign Bank Branches in Korea, various years. Tabic 4-21 Profitability of Foreign Banks in High Loans Clusters in Korea. 1983-1988' (ascending order) 1983 (Ouster #3) 1988 (Cluster #1) 1986 (Ouster #1) I.2 Sanwa Bank .002% 1. Sumitomo Bank .06% 1. Mitsui Bank -.17% 2. Dai-ichi Kangyo Bank .29 2. Yamaguchi Bank .32 2. Mitsubishi Bank .24 3. Barclays Bank .64 3. Dai-ichi Kangyo Bank .34 3. Fuji Bank .46 4. Fuji Bank .65 4. Mitsubishi Bank .41 4. Dai-ichi Kangyo Bank .60 5. Bank of Tokyo .78 5. Fuji Bank .52 5. Tokai Bank .66 6. Manufacturers Hanover .78 6. Bank of Tokyo .53 6. ABN .86 7. Bank of Nova Scotia .84 7. Bank of Nova Scotia .67 7. Barclays .87 8. Mitsubishi Bank .87 8. Tokai Bank .75 8. Bank of Nova Scotia .87 9. UBAF 1.02 9. Nat'l Bank of Pakistan .76 9. Sanwa Bank .89 10. ABN 1.02 10. Mitsui Bank .80 10. Bank of Montreal .92 11. Bank of Montreal 1.25 11. Barclays .80 11. United Overseas Bank .93 12. Crocker Nat'l Bank 1.27 12. Sanwa Bank 1.01 12. Sumitomo Bank 1.04 13.5 Morgan Guaranty 1.49 13. BNP 1.05 13. UBAF 1.27 14. Bank of America 1.10 15. Chemical 1.50 16. Bank of Montreal 1.60 17. Overseas B. of Singapore 1.69 18. United Overseas Bank 2.07 19. UBAF 2.09 20. First Interstate 2.17 21. Wells Fargo 2.62 Notes: 1. Return on assets = net income/total assets. 2. Least Profitable 3. Most Profitable Source: San Tong/Peat Marwick, Published Balance Sheets of Foreign Bank Branches in Korea, various years. Table 4-22 Top 10 Foreign Rants in Korea by Total Assets. 1983-88 1983 1986 1988 Bank Assets1 Market Share2 Bank Assets Market Share Bank Assets Market Share 1. Citibank W 986,753 14.9% 1. Citibank W 1,289,895 12.4% 1. Citibank W 1,084,877 8.6% 2. Chase Manhattan 472,413 7.2 2. Chase Manhattan 706,878 6.8 2. Chase Manhattan 1,077,406 8.6 3. Credit Lyonnais 416,899 6.3 3: Fuji Bank 488592 4.7 3. Fuji Bank 646,954 5.1 4. Bank of America 379,806 5.7 4. Bank of Tokyo 484,187 4.7 4. Credit Lyonnais 610,821 4.9 5. Manufacturers Hanover 287,689 4.3 5. Standard Chartered 426,749 4.1 5. Bank of Tokyo 583,160 4.6 6. Bank of Tokyo 252,007 3.8 6. Bank of America 418,144 4.0 6. Hongkong & Shanghai 546,430 " 4.3 7. BCCI 243,863 3.7 7. Manufacturers Hanover 414,125 4.0 7. Banque Paribas 544596 4.3 8. Fuji Bank 233,840 35 8. Mitsubishi Bank 385584 3.7 8. Standard Chartered 508,399 4.0 9. Morgan Guaranty 214,149 3.2 9. Bankers Trust 343,761 3.3 9. Manufacturers Hanover 489,966 3.9 10. BNP 183,398 2.8 10. Credit Lyonnais 323,722 3.1 10. Bank of America 431,946 3.4 Median 124,760 Median 152,005 Median 205,834 Smallest: Smallest: Smallest: Develop. B. of Singapore 31,751 Bank of California 21,022 Nat'l Bank of Pakistan 13,511 Notes: 1. In millions of Won. 2. As a percentage of foreign bank branch assets only. Sources: San Tong/Peat Marwick, Published Balance Sheets of Foreign Bank Branches in Korea, various years. Figure 3-1 Foreign Ranks in Japan1 233 Cumulative total net of exits 100 i 1367 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 Note: 1. Year end, except March 31, 1989. Source: See Table 3-2. Central Bank Private — r — Ordinary — f i n a n c i a l (commercial) i n s t i t u t i o n s banks — Specialized • f i n a n c i a l i n s t i t u t i o n s L- Other fin a n c i a l i n s t i t u t i o n s Government Notes: The number of institutions appear in parentheses. * The Second Association of Regional Banks is an associatioi banks. "• As of June 30, 1989. ••• Established in 1985 Source: Federation of Bankers Associations of Japan (1990), Figure 3-2 Financial Institutions i n Japan The Bank of Japan City banks (12) Regional banks (64) Member banks of the Second Association of Regional Banks (66)* Foreign banks (82) Financial i n s t i -tutions for foreign exchange Financial i n s t i -tutions for long-term credit Financial i n s t i t u t i o n s for small businesses Financial i n s t i t u -tions for agriculture forestry, and fishery Specialized foreign exchange bank (1) Long-term credit banks(3) Trust banks (7) — r Banking Foreign tru s t a/c banks (9)*** L Trusts a/c k-All banks (153) Sogo (mutual) banks (2)* Shinkin banks (credit associations)(454) Credit cooperatives (414) Shoko Chukin Bank (Central Cooperative Bank for Commerce and Industry (1) Labor banks (47) Norinchukin Bank (Central Cooperative Bank for Agriculture and Forestry)(1) — Credit federations of a g r i -c u l t u r a l cooperatives (47) Credit federations of fishery co-ops (35) Ag r i c u l t u r a l cooperatives (3,745) Insurance r — L i f e insurance companies (26) companies '— Property/casualty insurance companies (23) Securities firms (271) Private housing finance companies (11) Tanshi ( c a l l loans) firms (6) Securities finance companies (3) Banks (2) Finance corporations (10) Public "corporations (1) Others 1 — Post o f f i c e s (23,986)** I— Trust Fund Bureau (1) former sogo banks that changed their status to ordinary banks after February 1989 and of two sogo banks that have not yet made the change to ordinary Cumulative total net of exits Figure 3-3 Foreign Banks in Korea1 235 60 50 40 30 20 10 0 1966 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 J I L J I I I I L A i ' ' I I I L Note: 1. Year end. Source: See Table 3-13. Figure 3 -4 Financial Institutions i n Korea Central Bank Banking Institutions (Deposit Money Banks) Securities Market Commercial Banks Specialized Banks Development Institutions Savings Institutions Non-Bank Financial Institutions Investment Companies Insurance Companies The Bank of Korea Nationwide Commercial Banks (7) Local Banks (10) Foreign Bank Branches (52) Korea Exchange Bank Small and Medium Industry Bank Citizens National Bank Korea Housing Bank National A g r i c u l t u r a l Corp. Fed. Nat. Fed. of Fisheries Coop, and Member Coop. National Livestock Coop. Federation Korea Development Bank Export-Import Bank of Korea Korea Long Term Credit Bank Trust Accounts of Banking Institutions (18) Mutual Savings and Finance Companies (240) Credit Unions (5,512) Mutual Credit (1,627) Postal Savings of Post Offices Investment and Finance Companies (32) Merchant Banking Corporations (6) L i f e Insurance Companies (6) Postal L i f e Insurance of Post Of f i c e Securities Supervisory Board Korea Stock Exchange Securities Companies (25) Korea Securities Finance Corp. Sec. Investment Trust Companies(3) Note: Figures in parentheses represent the number of institutions as of the end of June 1985. Source: Bank of Korea (1985). Figure 4-1 1979 © 4 BANKS H IGH D E P LOW G T E E L O W H O M S - 19.8% 0 4 BANKS H IGH D E P L O W H O M S - 8.0% (t) t BANKS H IGH G T E E L O W L O A N S M S • 6.3% 0 SI B A N K S AVG . H I G H L O A N 8 1 2 N E W 20 M S > 48.9% 1 EXIT (5) 19 B A N K S AVO • L O W L O A N S 8 M S • 21.8% 1 9 N E W 3 Z > 0> NOTE: L KUJfBERS ON ARROWS INDICATE NUMBER OF BANKS MOVING FROM ONI OROUP TO ANOTHER 1 CTRCXKD NUMBERS IN UPPER LEFT OF EACH BOX INDICATE CLUSTER NUMBER 1. MS . MARKET SHARE WROA - WEIGHTED AVERAGE RETURN ON ASSETS Summary of Ouster Analysis for Japan. 1979-1989 1983 1986 © S3 B A N K S AVG • H IGH L O A N S M S • 43.3% WROA - 0.21% I 4 NEW^> _2fi_ 0 34 B A N K S AVO - L O W L O A N S M S - 38.7% WROA - 0.11% 1 EXIT © 8 B A N K S HIGH D E P HIGH L O A N S M S - 14.6% WROA > 0.17% © 5 B A N K S m a n DEP H I G H G T E E M S « 3.8% WROA - 0.32% 0 46 B A N K S A V O I 2 NEW © 2 B A N K S L O W H O 2 M S • 0.8% WROA - 0.08% 0 2 B A N K S H IGH S E C H IGH G T E E 2 M S - 1.8% WROA - 0.02% A/ M S - 67.1% WROA • 0.14% © 16 B A N K S H I G H D E P M S - 23JS% WROA - 0.27% © S B A N K S L O W L O A N S L O W H O M S - 2.4% W R O A • 0.63% ® 6 B A N K S H I G H G T E E M S - 6.2% WROA • 0.31% ® 3 B A N K S H I G H S E C M S - 0.8% WROA - 0.48% Source: See Section 4.3. 1989 26 0 2 N E W © 39 B A N K S AVO . H I G H L O A N S MS - 81.3% WROA - 4.06% 5> T O 5> (g) 18 B A N K S A V O - L O W L O A N S M S m 16.8% WROA - 0.01% ® 36 B A N K S AVO M S - 89.7% WROA > 0.12% tl) • BANKS HIGH D E P L O W L O A N S L O W H O M S - 4.7% WROA - 0.11% © 6 B A N K S man G T E E M S - 1.8% WROA - 0.21% ® 4 B A N K S L O W L O A N S H I G H S E C M S • B.6% WROA - 0.25% Co 238 Figure 4-2 Foreign Bank Loans & Discounts in Japan bv Country. 1979-1989 1979 U S A 57* L D C 7% F R A N C E 8% U K 8% U S A 12% Notes: 1. LDCs includes Brazil, Hong Kong, India, Indonesia, Korea, Malaysia, Pakistan, the PRC, Singapore, Taiwan and Thailand. 2. Other Developed includes Australia, Belgium, Canada, Italy, Luxembourg, the Netherlands, New Zealand, Spain and Switzerland. Source: Peat Marwick Minato, Published Financial Statement of Foreign Bank Branches in Japan, various years. 1983 Figure 4-3 Summary of Cluster Analysis, 1983-88: Korea 1986 1988 (2) 22 BANKS AVERAGE MS WROA 1 EXIT 69.56% 0.74% ( ? ) 13 BANKS HIGH LOANS 2 EXITS MS - 27.60% WROA - 0.90% ( T ) 6 BANKS HIGH SEC MS = 2.85% WROA = 1.06% NOTE: L NUMBERS ON ARROWS INDICATE NUMBER OF BANKS MOVING FROM ONE GROUP TO ANOTHER S. CIRCLED NUMBERS IN UPPER LEFT OF EACH BOX INDICATE CLUSTER NUMBER 20 3 NEW (2) 26 BANKS AVERAGE 4 EXITS MS - 71.54% WROA = 0.80% 13 BANKS HIGH LOANS HIGH HO LOW GTEES MS = 20.60% WROA - 0.66% (7) 7 BANKS HIGH SEC MS - 7.85% WROA = 0.92% 2 NEW ^/ ( ? ) 17 BANKS J\ HIGH GTEES N (AVG - LOW LOANS) MS - 48.91% WROA • 1.08% ( ? ) 2 BANKS LOW LOANS LOW HO HIGH SEC MS - 11.86% WROA - 1.74% 0 21 BANKS AVERAGE MS - 34.86% WROA - 0.81% (T) 6 BANKS HIGH DEP MS - 4.87% WROA - 1.00% 8. M8 - MARKET SHARE WROA - WEIGHTED AVERAGE RETURN ON ASSETS SOURCE: SEE SECTION 4JJ 240 Figure 4-4 Foreign Rank Loans ft. Discounts in Korea bv Country. 1983-1989 1983 USA 49% Notes: 1. See Figure 4-2 for definitions of "LDC" and "Other Developed" categories. Source: Peat Marwick Minato, Published Financial Statement of Foreign Bank Branches in Korea, various years. 

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