Global integration in the banking industry

Federal Reserve Bulletin,  Nov, 2003  by Allen N. Berger,  David C. Smith,  Jennifer Judge

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We also examine the distribution of bank nationality and reach according to the home nation of the affiliate, including countries outside the twenty host European nations (table 3). Of the foreign affiliates with corporate headquarters in European countries with both large and small banking sectors, 70 percent select a host-nation bank and only about 11 percent opt for a home-nation bank. This result is surprising, given that many of the European corporations have large home-nation banks close by from which to choose. In fact, the only outlier home nation is the United States. Of the affiliates whose parents are headquartered in the United States, 42 percent choose home-nation banks, a rate much higher than that for affiliates from other countries. This finding could reflect the ability of U.S.-owned banks to operate relatively efficiently in foreign countries, consistent with the academic literature. (15)

Although bank nationality and reach are two distinct concepts, they can be related. For instance, we have already seen that banks with local reach have, by definition, host-nation nationality. Other dependencies may result from how banks with a given reach are distributed across countries. For example, some countries do not have a global bank headquartered within their borders. Banks in these countries cannot offer both host-based expertise and global services to affiliates that value such a combination. Likewise, banks from these countries cannot jointly offer home-based and global services to affiliates of native corporations operating abroad. Finally, some banking systems may be too new or undeveloped to offer competitive banking services at even a local level.

We study potential dependencies between bank nationality and reach by assuming that bank reach depends first on the selection of bank nationality. We reason that, in the absence of barriers to integration, a bank's reach will be limited by the extent to which customers value cross-border banking relations. For example, in the extreme case that all bank customers selected host-nation banks for all of their services, there would be no need for banks with global reach.

A two-stage decision tree illustrates our framework (diagram 1). In the first stage, an affiliate decides on bank nationality; in the second stage, it chooses bank reach. Note that by definition, a local bank does not arise as a second-stage choice when an affiliate chooses a home-nation of third-nation bank in the first stage. At the nodes of the top branches of the tree, we report the sample frequencies for selecting a host-nation, home-nation, and third-nation bank, while at the bottom branch nodes, we report the sample frequencies for selecting a global, regional, and local bank given the prior choice of bank nationality.

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As shown earlier, almost two-thirds of the affiliates use host-nation banks over home- and third-nation banks (table 2), a pattern consistent with strong host-based expertise. Affiliates' choices for bank reach differ greatly, depending on bank nationality (diagram 1). After selecting a host-nation bank, about 21 percent of the affiliates use a global bank. By comparison, of affiliates that select either a home-nation or third-nation bank, about 63 percent use a global bank. In other words, affiliates tend to use banks with global reach once they choose a home-nation or third-nation bank, but they tend to use a regional or local bank once they choose a host-nation bank.