International Expansion Of Banks In Emerging Economies: Motivational Factors And Challenges

Internationalization of Banks

The paper presents a detailed analysis of the motivation for the banks to expand internationally in the emerging economies. The discussion incorporates critical discussion by referring to the academic literature from the academic books and peer reviewed journals. There has been so much news concerning the emerging economies growth and the banks based on such market have been gaining strength in the recent years, which serves as the basis for the foreign banks to expand in such emerging market (Obstfeld et al. 2019). Financial crisis impact on the banks based in the emerging economies were less impacted, which is evident from their strong balance sheet. Such banks have demonstrated that they are well equipped to adapt to the market place issues and to innovate. Banks in the emerging market have raced ahead of their western counterpart (He et al. 2019). Over recent years, banking sectors have growth at an extraordinary rate in the emerging economies. It is estimated that over the next ten years, banking sector of the emerging economies would contribute 60% of the growth in the revenue of the global banking. In the world of banking, it is likely that the E7 economies (China, Brazil, Russia, India, Mexico, Turkey and Indonesia) would become increasingly significant in the banking world. Banking sector in such emerging economies is expected to grow considerably faster than GDP (Deloitte.com 2022). Activity of merger and acquisition is likely to witness correspondingly strong growth because the international and domestic banks jockey for prime position. Emerging economies is expected to provide opportunities for the international expansion of banks.

In the business history, banks international operations have been the focus of significant research and it is suggested by a strand of literature relaying to the internationalization of banks that regulations render market less contestable by mitigating competition. In general, international expansion of banks is motivated by the objective of strengthening their position in the home market. Another motivation to internationalize is to add the new sources of income by diversifying their stream of income. A paper focusing on the stabilization of the foreign banks found that lending during the crisis by the foreign banks in the emerging European countries has been stable compared to lending by the domestic banks and expansion can help banks in transferring liquidity following liquidity shocks. The motives of the bank internationalization in the emerging market can be identified to be intrinsically associated with the strategic knowledge sourcing, government policies and market development to serve customers operating overseas (Ibrahim and Alagidede 2018).

Motivational Factors behind the International Expansion of Banks in the Emerging Economies

Banks internationalization is underpinned by two main reasons such as banks having competitive advantage that is home grown internationalize to maintain or retain that advantage. Banks when internationalization follow their customers abroad to protect their valuable business from their overseas competitors and to service them. “Follow the customer approach” of banks is viewed as a defensive strategy to retain valuable customer both in home and host country and thereby preventing loss. Extended literature on the hypothesis of defensive expansion have found that bank from the advanced nation such as Japan expand internationally to reap the benefits of internationalization to achieve the economies of scale by following existing customers. The second driver of bank internationalization is to obtain competitive advantage and strategic assets and the reason being consistent with resource-based view that highlights importance of capabilities and resources of firms in competitive sustainable advantage attainment (Alaaraj et al. 2018).  Foreign banks entry in the emerging economies impact the domestic banks in various ways and the efficiency of the domestic banks improves from the resource transfer. It is suggested by the evidence from the literature that the positive effects of the resource transfer and the foreign competition is dominated by the negative effect of the foreign competition. More of the negative effect from the foreign competition can be could be offset as the effect of resource transfer is more prominent for the developing countries.  This provide the plausible explanation of why the banks in the emerging economies is less impacted by the presence of foreign banks (Giannetti and Ongena 2012).

Inspection on the internationalization of banks in the emerging markets can be explained by a literature strand. It says that the improved bank performance is gauged by the profitability, net interest margin, cost and other measures of performance. A paper investigating the efficiency of foreign banks with that of domestic banks found that the foreign banks due to their superior scale efficiency are input efficient compared to the domestic banks. Incentives of foreign expansion of banks can be attributable to the uncompetitive market of the host country (Ashraf and Shen 2019). In addition to this, banks might be induced to devise competitive strategies due to advent of new technologies and changes in the regulation is order to operate distinctively.  

A study on cross country globalization of banks found that the risks of bank entering in the emerging market increases. In emerging countries, the foreign owned banks take on risks which is more than their domestic counterpart. However, they generate higher profit in the developing or the emerging economies against the domestic banks. The findings cannot be regarded as universally conclusive because of the variation in the study by regions or countries. It is indicated by some study that domestic banks are less efficient than foreign banks, while other studies have found that compared to foreign banks, domestic banks can be less efficient (Cardenas et al. 2003). Banks in the developed economies are perceived to be more efficient compared to the developing economies due to the differences owing to management proficiency, technology and institutional environment. It is also argued that developed market banks hold comparative advantage against their counterparts in the emerging economies due to the efficiency. Therefore, the presence of banks particularly from the advanced economies is expected to have greater impact on the bank efficiency in the developing markets that the other way round. Based on the assumption that foreign banks efficiency in the emerging economies, is more than the incumbent banks there, it can be said that the efficiency gain would be more in the emerging economies compared to advanced economies. This conjecture is supported by both the competition effect and the argument of resource transfer (Deng et al. 2018).

Challenges faced by the International Expansion of Banks in the Emerging Economies

A perfect example of international expansion of bank in the emerging market can be given by HSBC Holdings Plc, which is the third largest bank in the world based on assets. Competency of bank relied in local trade financing and with the opportunities available in various emerging markets, strong relationship was developed by the bank with the local government. The bank expanded in some major port cities of Asia such as Vietnam, India, Malaysia, Myanmar, Indonesia, Philippines and Singapore. Presence of bank in such emering market was enlarged by their diversification to support additional industries. Also, HSBC was shielded from the Great Depression fallout because of their regional focus in the emerging markets, exceptional client relationship and financial strength. Expansion efforts of bank in these key markets helped them to emerge as global player (Li and Tanna 2019). Moreover, in order to evolve as a leading international bank of the world, the multinational bank is still focused on capitalizing on the trends of capital flows and international trade alongside wealth creation and economic development in the emerging economies.

Foreign banks intending to expand in the emerging economies have to face several challenges in terms of domestic infrastructure issue, financial infrastructure and political instability.   “Psychic distance” can be cited as one of the challenges which the bank might face when entering into the emerging economies. It happens when there is a significant difference between the business practice, level of economic development, level of education, cultural and language between the home and host countries. Banks with high cultural from distinctive countries entering the emerging economies might face challenges in bridging the cultural differences between the host and home country. Various research works have found that the banks facing challenge in respect of the cultural distance of the host country tend to use their entry strategy of non-equity modes (Singleton and Verhoef 2010). The degree of institutional risk in the host country is determined in the institutional context and when the formal institutional risk is high, banks operating in such environment faces additional cost and restrictions. Due to the existence of psychic distance, banks might have to bear additional cost as they need to adapt to the culture of host country. For instance, managers from the foreign banks might possess weaker knowledge of borrower behaviour in the developing economies as they have less information on borrowers’ quality. A literature presenting comparative performance of foreign owned and domestic banks concludes advantage of domestic bank over foreign bank. The reasons seem to be associated weaknesses of the foreign owned bank such as organizational diseconomies in operations, cultural barriers and monitoring from distance (Ashraf 2018). Therefore. It is inferred that cultural barriers present a significant challenge when expanding in emerging economies.

When measuring the efficient of banks expanding in the emerging economies, it was found that for the foreign banks, the operating cost to income ratio is significantly higher than the domestic banks. Higher operating to income ratio in the emerging economies for the foreign bank can be attributable to the fact that since labour cost forms a significant percentage of the cost base. Foreign bank tends to pay their employees mores and the revenue generated per employee is also significantly higher compared to the domestic bank where productivity of labour has been low because banks have significant ownership in the public sector (Yin et al. 2020).

The scale and speed of external shocks transmission has been amplified due to the increased interconnectedness of the emerging markets with the global economy from financial and trade linkages. This poses significant challenges to the banks in mitigating and managing the cross-border contagion risks, particularly, when the financial market of the emerging economies is less developed. The importance of having clear cooperation mechanism and accountabilities in overseeing the foreign banks operation is reinforced from this fact. The development on supervision, information sharing, institutional failure resolution, burden sharing and surveillance would contribute towards bridging the differences in practice and approach of home country and host country. Some other major challenges for the banks intending to internationalize their expansion in the emerging markets is maintaining their competitive strategy by the adoption of right strategy (Yin et al. 2020).

Apart from the above discussed challenges faced in internationalization of banks in the emerging economies, other challenge includes management challenges. Challenge pertaining to management includes managerial capability to learn the local customer perspectives, management system and organizational structure and strategy of internationalization when expanding in the emerging economies (Obstfeld et al. 2019).

Localization difficulties poses a big challenge for the foreign banks intending to enter the emerging economies. Such challenge can be identified in terms of adapting to the local institutional context, developing local customers and establishing relationships with the local financial communities. Attracting the local customers can be identified as the biggest challenge as it determines the bank’s ability to integrate with the local culture.  Compliance management poses a significant challenge as it tends to increase the cost of transactions. Operational and regulatory restrictions considerably impact the foreign banks decision to expand abroad (Yildirim and Öztürkkal 2022).

Fragility of the emerging economies is compounded by the financial framework that is less developed and these comprise of lack of string institutions, shallow local financial market, surveillance and supervisory capacity, lack of macroprudential tools and technical expertise. Furthermore, funding cost and asset price might be directly affected in the emerging economies due to the spill over effects of the liquidity (Yildirim and Öztürkkal 2022).  A fire sale cycle could be produced in the worst-case scenario due to the liquidity mismatch.

Furthermore, expansion by the banks in the emerging economies also faces the challenge in terms of the wide range of incentives and economic behaviour adversely impacted by the high level of global debt generating debt overhang effects. There has bene continuous rise in the total debt of the emerging economies in 2013 indicating the rise to 212% of GDP. It is because the developing and merging economies leveraged growth post crisis by pursuing countercyclical and debt fuelled measures to support the growth. The feedback loop created due to such measures where the concerns of the debt sustainability result in deflationary pressures and undermines nominal economic growth. Due to this, additional doubt on the sustainability of debt is casted (Piperopoulos et al. 2018).  Hence, such interrelated financial challenges pose headwind for the emerging economies and causes the international banks to be dicey about their expansion.

Conclusion:

From the overall analysis of various facts, it can be understood that the foreign banks expanding in the emerging economies has various motivating factors to carry out their operations. At the same time, banks are faced with several challenges and they are requiring to overcome such challenges for the successful expansion. The findings about the foreign banks improved efficiency in their home country justify the outward investment importance of the financial sector and the strategy of globalization adopted by the banks. Banks can improve their efficiency in their home country by allocating their resources in a better way, if they have international presence. Resource allocation and international learning effects of the international expansion could make contribution in improving the efficiency of banks in the home countries.

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