In recent times, emerging economies have surprisingly produced their own indigenous multinational companies. This development is described as surprising, simply because neither earlier economic theories nor more recent theories of the multinational enterprise anticipated such a development. Theories suggest investments should flow into, and not out of deprived countries, and also that companies attain the multinational status particularly as a result of innovations which are expected to be present in highly developed countries, rather than in emerging economies (Goldstein, 2007). However, these assumptions have been increasingly challenged by multinational companies from countries like India, China, South Africa, Brazil, Egypt and in this particular case Nigeria.
Companies from most of the countries mentioned above are a combination of manufacturing and service companies, which include the likes of Ranbaxy, an Indian pharmaceutical company, Lenovo a Chinese computer manufacturer, such as Tata, Wipro, and Infosys all Indian technology services companies, South African brewer SAB-miller, Brazil's Embraer, one of the world's leading aircraft makers and China's Huawei Technologies Co. Conversely, the highest proportion of Nigerian companies expanding to foreign countries are Nigerian Banks. A considerable number of which now own and operate branches or subsidiaries in various countries within the West African region and beyond. The multinationalisation of these banks represents the main focus of this study, with a microscopic look at the challenges they face and the impact of internationalisation on their performance. But before I proceed, I present some empirical data about the magnitude of multinational banking amongst Nigeria banks, highlighting the name of the bank, country where they are located, the type of presence and the year of first entry into the country.
2.1 Existing theories of Multinational Companies
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The internationalisation of companies has been studied using various contextual frameworks. Over time, numerous authors from different disciplines such as economics, business management, and sociology have examined this trend among companies, particularly those from developed economies. According to research, a company may engage in international business through importing and exporting, the licensing or sale of technology, foreign management contracts, trade of turnkey projects, strategic alliances, or through Greenfield foreign direct investments. The eclectic paradigm, behavioural models, dynamic capabilities and resource based view, the monopolistic advantage and product life cycle, are all examples of theories which have been developed to explain the internationalisation of firms.
2.2 Definition of Multinational Banking
A bank may be typically defined as an institution where people and other institutions can invest or borrow local or foreign money. Mark Casson (1990) suggests that the definition of a bank varies depending on the context of analysis. He describes a bank as "an institution specializing in the purchase and claim of currency, or claims to currency". Banks sometimes specialise in various activities, as banking can be segmented, hence it is not a standardized activity. According to Casson (1990), banking consists of a group of unique but related activities which can, and are often conducted by different individuals, in different locations. Therefore, as banks conduct there core banking activities such as receiving deposits, giving out loans, and exchanging currency, they also provide such services as the issuing of notes, securities services, clearing and settlement related services and so on. Casson (1990) then describes the Multinational bank as "a bank that owns and controls banking activities in two or more countries". This definition of the multinational bank is widely encompassing, as it stresses the importance of not just owning banking activities in another country other than the home country, but the bank in question must also control (manage) such banking activities, meaning there has to be some kind of modification in the bank's organisational configuration. Hence, these definitions will be adopted for the purpose of this study.
2.3 History and Evolution of Multinational Banking
It is important to note that multinational banking is not a new phenomenon. According to Jones (1990), multinational banking occurred in two waves. The first of which emerged in the 19th century, with British banks being the broadest example. Appearing in the 1830s, British multinational banks operated with headquarters in Britain, but seldom conducted domestic banking activities in Britain. By the early 19th century they had set up huge branch networks in parts of the British Empire, particularly in South Africa and Australasia. The international expansion of banks varied from country to country. Other banks from different countries like Germany soon followed the British banks, with branches in London and subsidiaries in different locations such as Asia and Latin America. However, the multinational banks from Germany were mostly established by major German domestic banks through consortiums. Multinational banks from France adopted a comparable approach to multinational banking as their German counterparts; they too were set up by domestic banks. On the other hand Japanese banks foreign expansion was highly facilitated by the Japanese government in response to western initiatives (Tamaki, 1990). Surprisingly, American banks weren't very active in international banking in the 19th century. Swiss banks are believed to have also had little international presence during this period, though they undertook international banking activities. Cassis (1990) suggests that this may have been due to Switzerland's lack of colonial activities, a phenomenon closely linked with multinational banking during the 19th century.
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Some major characteristics of multinational banking during the 19th century were highlighted by Jones (1990). Firstly, most of them focused on setting up branches in developing countries; Secondly, multinational banks offered diverse banking services in their foreign branches, such as trade finance, investment banking and domestic retail banking services; Thirdly, banking across borders extended into multinational investments in other sectors. For instance, Barings Brothers & Co Ltd, a British merchant bank, invested directly in land development in Maine, while they were operating in the United States in the 1790s.
The second wave of multinational corporate banking began in the 20th century (Jones, 1990). Leading this wave, Commercial banks from America expanded rapidly to foreign countries (Huertas, 1990) while American investment banks discarded their dependence on intermediaries and started making foreign direct investments (Scott-Quinn, 1990). Major British banks with previously few or no international presence, opened branches in foreign countries and acquired branches in the United States (Jones, 1990). Between the 1960s and 1980s, Japanese banks had significantly increased there international expansion, having over 200 foreign branches (Kawamoto, 1987). However, Jones (1990) also highlights the differences between the first and second waves of multinational corporate banking. Some of the features he highlighted include;
2.3.1 Geographical location- Though multinational banks from both waves established in major financial centres, London became a key destination for banks, as a result of the creation of the Eurodollar market in the 1950s. The rise of the Asian Dollar markets, in addition to the emergence of offshore centres in the 1970s, also made Singapore, Bahrain and Hong Kong magnets for multinational bank branches. He also notes that multinational banks from the second generation paid more attention on developed economies, rather than the developing economies which their predecessors focused on. Deregulation in the banking sector of Australia and Canada in the 1980s also, encouraged multinational banks to locate branches there. Yet some American banks continued the pattern of 19th century banks by locating in some developing economies, principally in South America.
2.3.2 Products offered - Multinational banks from both periods offered similar products, but some differences were present. He suggested that the Eurodollar and the Eurobond markets where the major differentiating factor between products offered in both periods. In addition, domestic retail banking in foreign countries was becoming an unpopular trend among the 20th century banks. Because of the widespread notion that foreign banks attempting a domestic retail banking strategy were almost likely to fail, except by acquiring a local bank (Huertas, 1990).
Other authors have studied the international expansion of banks from other countries. For example, trade finance has been described as a major factor that fuelled the internationalisation of Arab banks in the 1950s and 1960s (Shoker, 1990). Norwegian multinational banks like German banks were a product of consortia relationships with other Nordic banks, due to restrictive domestic regulation in Norway between 1960s and 1970s (Boldt-Christmas et al., 2001). All these studies simply indicate that the institutional environment in which a bank like every other enterprise operates has an impact on its behaviour.
2.4 The development of Multinational banking: A theoretical viewpoint
In comparison to the multinational bank, a lot more research has been conducted on manufacturing multinational companies. This resulted in the development of a theoretical framework for understanding the behaviour of the multinational company, while the multinational bank suffered from not having a definite theoretical structure for a long period. As a result, numerous authors, for example, Grubel (1977), Gray and Gray (1981), and Casson (1990), who attempted to develop a theory for the multinational bank, found it useful to analyse the multinational bank through the lens of the manufacturing multinational. These authors tried to assess the similarities or differences in behaviour between the multinational bank and the manufacturing multinational, by essentially seeking the likely motivations for banks to internationalise. For instance, Grubel (1977) made an attempt to tackle this problem by firstly analysing various types of operations of commercial banks, namely retail banking, wholesale banking and service banking, which he then compared against the theory of the multinational company. And this led to the development of the very first theory of multinational banking, where Grubel (1977) suggests that "the basic analytical question to be answered by a theory of multinational banking is identical to that present in the case of foreign direct investment: what is the source of comparative advantage accruing to a U.S bank in a place like Singapore, which is in competition with local banks having obvious advantages in their familiarity with local customers, capital markets, employees and government? Put differently and applied to the special problem of banking, the basic phenomenon to be explained by the theory of multinational banking is why a bank abroad can profitably offer lower lending rates and higher borrowing rates than its domestic competitors and thus attract customers from them". Grubel (1977) argues that there are similarities between the theoretical explanation for multinational retail banking and that of foreign direct investment in the manufacturing multinational developed by Kindleberger (1969). Citing the use of management technology and marketing expertise, both of which can be deployed across borders at low marginal costs, as a source of competitive advantage to a multinational bank operating in a foreign country. Though he concedes that such advantages are trivial, considering the ease at which banking management technology can be accessed or acquired by banks generally. Grubel (1977) suggests that market imperfections from country-to-country enables multinational banks to stabilise their earnings through the geographic diversification of their business portfolio, and as such acts as an ample incentive for a bank to internationalise. Although a more recent study by Slager (2006) argues that not all multinational banks are able to stabilise their earnings through operating within different financial markets.
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Furthermore, regarding multinational service banking, Grubel (1977) linked the growth of world foreign direct investment to the emergence and growth of multinational banking. He explains that banks internationalise in a bid to protect the business relationship they have built with there local customers, by going abroad to serve the banking needs of the customer's foreign subsidiary, in order to avoid losing the customer to the domestic banks in the foreign country where the subsidiary is located. The ability of the banks to provide such services is based on the wealth of knowledge they possess about the business operations of their client, which makes it relatively cheaper and quicker to respond to the client's financial needs than any local competitor in the host country. By drawing on the knowledge about the taste and preferences of tourists or business people from their home country, multinational service banks can also extend their services to these groups of individuals in foreign countries where they have a presence, in order to ensure their customers do not seek alternative services from domestic banks in the foreign country (Grubel, 1977). The strategy of protecting relationships established with both corporate and individual clients is referred to by Grubel (1977) as a "defensive" strategy. Regarding the provision of wholesale banking services, though domestic banks can provide similar wholesale banking services to local clients, Grubel (1977) suggests that multinational banks have an advantage over their domestic counterparts. An advantage borne out of factors such as lower operating risk and/or cost, exemption from some domestic regulatory requirements, avoiding the marginal cost associated with retail banking (since they deal mainly with large customers), they also diversify their risks through the relationships they have with other multinational banks, which they use in facilitating loans to their customers. Wholesale multinational banks as a group typically act as conduits for the flow of capital among nations, by identifying where there are excess funds and channelling them to locations where there are shortages through a fast and efficient system (Grubel, 1977). In opposition, Aliber (1984) in his evaluation of literature on international financial intermediation criticised Grubel's attempt, claiming the theory fails to provide a solid explanation on the source of advantage which the multinational bank has over its domestic competitors.
In slight contrast to Grubel's approach, where he conducted an analysis of the multinational bank by contrasting three different operational categories of commercial banks against the theory of the multinational company, Gray and Gray (1981) approached the analysis of the multinational bank by applying the core characteristics of the theory of the multinational company to the trend of multinational banking. Gray and Gray (1981) argued that the "conditions which generate efficiency gains and augment profits in multinational banking are the same as those which apply to non-financial multinational corporations". They employed Dunning's eclectic model as a tool for explaining the behaviour of the multinational bank, by looking at the ownership-specific advantages, internalisation incentive advantages and the location specific variables that may trigger the multinationality of a bank. In a bid to simplify the application of the eclectic theory to multinational banking, Gray and Gray (1981) decided to make the assumption that the ownership-specific advantages required for a bank to consider internalising its efficiencies already exist, therefore, they focus on the internalisation incentive advantages and location specific advantages of the theory. Further, Gray and Gray (1981) explain that before a bank can consider multinationality, it must possess the ability to provide a specialised service that can be applied beyond its home market, or it must possess a reputation for either efficiency, provision of quality information or creditworthiness (the assumed ownership specific advantages) which will enable it benefit from extending its operations beyond its domestic market. Building on Grubel's (1977) study, Gray and Gray (1981) identified circumstances which may act as incentives for banks to expand into foreign markets. The conditions identified were based on the features of the eclectic theory; internalisation efficiencies and location specific considerations. The conditions include imperfections in product markets, economies of internal operation, preservation of established customer accounts, entry into growth markets, ensuring access to raw materials and the escape motivation from home or host country regulations. The commercial bank's multinationality is derived from two sets of forces. The first set of forces lets the commercial bank reap the inherent benefits of having a presence in a foreign national market (which hosts both foreign and domestic banks), while the second makes it possible for the bank to operate in a supranational financial market (where activities are mostly confined to off-shore banking, with less regulatory constraints). Thus, the multinational bank is not only able to take advantage of different national markets like its non-financial opposite number, but it is also able to gain considerably from connecting national markets with the supranational market. And the latter point above was suggested to be a more significant factor in comparison to the former (Gray and Gray 1981).
The eclectic paradigm represents a basic reference in the multinational enterprise literature, due to its eclectic method, enormous explanatory strength, and improved measurability (Goldstein, 2007). Also, considering the fact that Dunning's eclectic theory has been successfully employed by numerous authors (e.g. Grubel, 1977, Gray and Gray, 1981, Yannopoulos 1983, Casson 1990,etc) to the analysis of the multinational bank, this theory will be adopted for the purpose of analysing the multinationalisation of Nigerian banks, which represent the focus of this study. An overview of the eclectic theory is given below, followed by its application to the multinational bank.
2.5 John H. Dunning's Eclectic Theory
According to John H. Dunning's (1977, 1980) eclectic theory, the foreign direct investment decision is a combination of three interrelated factors. These factors are itemised as follows; Ownership specific, internalisation, and location specific factors. All three of the aforementioned factors of the eclectic theory are considered to have a crucial impact on the investment decision by the multinational enterprise. A combination of the internalisation, industrial organisation, and the location theories, the eclectic theory proposes that prior to becoming multinational, a company must possess an ownership advantage, which needs to be internalised (often as a result of market failure), following which location specific variables will determine the place (country) where the multinational enterprise invests.
Table 1.2 below highlights the eclectic framework of different investment types
2.5.1 Ownership Specific Advantages: According to Dunning (1988), these advantages (also known as firm specific advantages) are borne out of three things; they include, access to credit from the parent company at little or no cost, access to markets, as well as factors resulting from being multinational (e.g. exploitation of different markets). Normally referred to as "intangible assets", these advantages will allow a company from one country to compete in another alongside the host country's domestic organisations, who already possess the advantage of being home-grown, resulting from there being more familiar with the people, market and the environment in general. Such ownership advantages basically represent a precondition to becoming multinational. Examples of these advantages include innovation (e.g. research and development), product differentiation, economies of scope, core competence in managerial or entrepreneurial capacity, monopoly knowledge of markets or products, etc. Most of which are developed over time and allow the multinational to overcome the costs attributed to operating in a foreign country (Dunning, 1988).
2.5.2 Internalisation Advantages: Dunning (1988) argues that the need for internalisation is as a result of market failures. In order to take advantage of these market failures, the multinational company opts for an organisational form (varying from arm's length transactions to a wholly owned subsidiary) which is most favourable to it. And by internalising numerous activities within the organisation, transaction costs can be reduced to the minimum in an inefficient market.
2.5.3 Location specific advantages: Also known as the country specific advantages, this element of the eclectic paradigm determine where the multinational will internationalise to. Dunning (1988) explains that a firm will expand to foreign markets to match its ownership advantages with available factors of operation in a country and earn revenues as a result. Hence, this advantage is interdependent with both the ownership and internalisation decisions. Location advantages may include the economic performance of the host country, institutional arrangements, input prices (e.g. labour costs), tax regimes, trade barriers, socio-political situations, cultural differences, etc. It is these country specific advantages that clarify why multinational company decides to have a presence in a certain host country through FDI, as opposed to conducting business with the country from a distance.
Therefore, the chronological nature of these advantages indicates that an ownership advantage has to exist, prior to internalisation of activities, due to market failure. Following which location specific factors will point to the direction where the investment goes (Dunning, 1988).
2.6 Application of the Eclectic Theory to Multinational Banking
In a bid to simplify the application of the Eclectic theory to multinational banking, Gray and Gray (1981) assumed that the multinational bank already possessed the required ownership advantages. This decision to make such an assumption resulted in a shift in focus to the location and internalisation advantages of the multinational bank. However, the approach was further developed by Yannopoulos (1983). According to Yannopoulos (1983) the eclectic theory was broad enough to accommodate the different markets where the multinational bank operates i.e. the national and supra-natural markets (e.g. Euromarkets). Ownership advantages are a very critical element of the eclectic model, as they are a prerequisite to the banks ability to neutralise or even overcome the advantage the domestic banks have in the host country. One of such ownership advantages is product differentiation, a noteworthy advantage in banking, which has been suggested by Yannopoulos (1983) to be a product of two factors: the first is the importance of certain major currencies (e.g. the dollar) in international trade and finance. While the second is the importance of non-price competition in the banking services market. Described by Aliber (1984) as the currency clientele, the importance of major currencies will attract customers to the bank which is incorporated in the country of origin of the transaction currency, due to the bank's established ability to carry out transactions denominated in the currency in question. However, Lewis and Davis (1987) contend that banks do not require a physical presence abroad in order to exploit the currency clientele advantage. They suggest the advantage could equally be enjoyed through correspondent banking. Nonetheless, Yannopoulos (1983) went further to suggest that a multinational bank can engender both short-term and long-term advantages for itself through apparent differentiation and perceived product differentiation respectively. While apparent differentiation is associated with the terms of the service provided by the multinational bank, perceived differentiation is related to the bank's credit rating, it's supposed possibility of loan renewal, and its size. However, factors associated with perceived differentiation (e.g. bank size, credit rating, etc) are believed to produce a more sustainable advantage for the multinational bank, considering the difficulty of imitating them (Merrett, 1990).
Internalisation in multinational banking basically springs from information (Williams, 1997). For instance, the need of a multinational bank to internalise the relationship it has with a company from its home country by providing banking services to the company's subsidiary in a foreign market is based on the information the bank possesses about the business needs and general operation of the parent company. Yannopoulos (1983) and Boldt-Christmas (1987) both advice that information has a vital purpose in multinational banking, giving that the relationship between a bank and its client is essentially based on information flow. Furthermore, due to factors such as the rather short valuable life of most information and the advantages of owning the information gathering process (Buckley and Casson, 1987) it is necessary for a bank to have a direct physical presence in foreign markets. Although they are crucial, location specific variables are not enough for a bank to internationalise (Williams, 1997). Yannopoulos (1983) highlights examples of location advantages in multinational banking to include varying regulatory structures, geographical distribution of the bank's clients, investors risk exposure, labour migration leading to the banks accompanying their retail customers, access to skilled labour and information gathering.
An additional application of the eclectic model to multinational banking by Cho (1985) provided other explicit examples of the three elements of the model in relation to multinational banking. Considered to have the possibility of being short-lived (Williams, 1997) ownership advantages were classified by Cho (1985, 1986) to consist of managerial resources, wide spread and efficient banking networks, favourable financial sources, experience and knowledge in multinational operations, skilled human resources, prestige, ascertained credit worthiness, differentiation of banking products, and expertise in servicing a certain customer type. He went further to suggest that information provides the opportunity for the bank to distinguish itself by targeting its products to a specific group of customers or markets on the basis of having greater knowledge. Cho (1985 and 1986) then classified location advantages into five categories; regulatory frameworks, effective interest rate differences, different economic situations, nationality of banks, and socio-economic differences. Also classified in to five categories are internalisation advantages, the first category is the availability and cost of fund transfer within the multinational banks, second is efficient customer contacts, third is transfer pricing manipulation, fourth are improved networks for information gathering and the last is the potentially reduced earning variability.
2.7 Incentives for banks to expand abroad
Various factors influence the decision of banks to venture into foreign markets. The following section explains some of the factors that influence the decision of where banks go when expanding abroad.
Kindleberger (1983) examined the customer leading and customer following incentives of banks to internationalise. He concluded that banks can act both as leaders of customers to foreign markets, and also as followers of their customers to foreign markets, explaining that neither internationalisation incentive overrides the other. Aliber (1984) suggested that banks based in countries with a high ratio of market to book value seem better placed to expand to foreign countries. Furthermore, research on Japanese banks' international expansion indicated that regulation could act as a catalyst for a bank's foreign expansion (Poulsen, 1986), while regulation has also been identified to be an obstacle to the entry of banks into foreign markets (Tschoegl, 1987). Jones (1990), attributes the internationalisation of banks to "entrepreneurial perceptions of profitable opportunities in conditions of expanding territories and imperial frontiers, a desire to apply domestic banking skills in foreign markets, the wishes of politician for banks", the value of having a presence in major international financial centres and the establishment of branches in foreign countries in order to maximise profit by limiting the role of intermediaries. There are also arguments about the most suitable theory to be employed in analysing the reasons why banks internationalise, and their ensuing performance therein. Williams (1997) argued that the internalisation theory provides a more encompassing framework for examining the multinationalisation of banks, than the eclectic theory which has been used by numerous authors. Although he concedes there is little between both theories regarding there ability to provide an explanation for multinational banking. Table 1.3 below highlights some of the main incentives put forward by a host of authors to explain why banks internationalise. This is then followed by an individual analysis of the incentives.
Like the Japanese automobile component manufacturers who accompanied Japanese car makers to the US (Banerji and Sambharya, 1996), banks also follow their customers abroad. According to Metais (1979, cited in Aliber, 1984) the act of banks following and serving their customers abroad can be described as the gravitational pull effect. This action has been attributed to numerous reasons. For instance, it has been suggested that due to the inability of domestic banks in the host country to effectively service the needs of foreign company subsidiaries or branches, banks from the home country of these companies are encouraged to internationalise, especially in a situation where the level of financial innovation or expertise in the host country is inferior to that which is obtainable in the home country. This factor has been proposed as an explanation to the development of overseas branches of colonial banks in the nineteenth century whose branches were mainly located in developing economies (Aliber, 1984). Another reason why banks tag along with their customers during international expansion is that banks try to mitigate the risk of loosing their customers to domestic banks in the host country where their customers expand to, especially if the level of banking in the host country is more advanced than that of the home country. According to Walter (1988) a bank's presence in a foreign country helps it strengthen its relationship with firms from its home country. Thereby ensuring the client-bank relationship is further enhanced. Put simply, banks follow their clients abroad to maximise the internalisation benefits developed in the home country, thereby providing additional collective gains for both parties (Slager, 2006). On the other hand, banks can also act as leaders of their domestic customers into foreign markets. Walter (1988) suggests that a bank with a strong presence abroad can offer the services required to support the decision of a company to expand to the host country where the bank already has a presence. Given their experience operating in such host countries, multinational banks can spot business opportunities which may be favourable to their domestic clients back home, and facilitate their entry into the market by making use of their knowledge of the environment.
2.7.2 Market perception
Perception is basically a way of conceiving something. For example, upon seeing images of a country at war, an arms dealer would see an opportunity for the sale of his products, while the regular guy would see devastation and suffering; simply put we see things differently. Banks sometimes establish across borders in order to explore possible opportunities if they feel their home market presents them with little or no prospects. This occurs predominantly with banks from underdeveloped home markets (Slager, 2006). Hence, in order to provide customers with demanded products, banks expand to foreign countries. This was a common feature among 19th century and 20th century multinational banks, who established branches in major financial centres like London, New York, Bahrain, Singapore and Hong Kong (Jones, 1990). These banks were mainly encouraged by the emergence of the Euro dollar and the Asian dollar markets. According to Gray and Gray (1981) banks will be drawn into foreign expansion by seeking more opportunities in foreign financial centres. Another factor that may be responsible for modifying the perception of markets is the lowering of boundaries through political or economic integration e.g. NAFTA, ECOWAS, and the EU (Slager, 2006).
There are three main sources of income for banks; the net income interest on loans (also known as the spread), non-interest income, and the fee income. However, the major profit driver for most banks is the spread. Because interest income is subject to economic cycles and interest rate levels, banks are sometimes driven towards foreign expansion in order to earn more from higher spreads in other countries. For example, a Ghanaian bank may set up a subsidiary in a country where interest rates are low compared to the rates in Ghana, in order to source funds at cheaper rates, and then lend to its customers in Ghana at a higher rate. According to Aliber (1984) difference in spreads is a location specific advantage which is an indication of the benefits a multinational bank can exploit when it enters a foreign country.
2.7.4 Differences in economic structure
Another possible incentive for banks to expand abroad is the structure and level of growth in their domestic economy in comparison to foreign economies. Banks can exploit the differences in financial systems, economic cycles, economic structures as well as demographic variations (Slager, 2006). Increased economic growth in countries typically results in the increase of lending to customers (corporate and non-corporate) to finance projects and also an increase in deposits as people's income rises, leading to a boost in the profitability of banks. For instance, Spain's Banco Santander announced its second quarter results for the year, and it indicated that its revenues were largely augmented by its Latin American operations, due to high business growth in the region (CTV Globe Media Publishing Inc., 2008). According to Demirgüc-Kunt & Huizinga (2000) countries with less developed financial systems have notably higher levels of bank profit and margins. Therefore, with regards to the international expansion activities of banks, geographical location is crucial and may represent the difference between being successful internationally or not.
Regulation represents one of the most crucial and underlying factors that characterise the foundation of any industry. Firms both locally and internationally are subject to regulatory control in order to protect them and the environments in which they operate from exposure to various risks. And regulations most times differ across industries from country to country. In the banking industry regulation is very vital, in fact, regulation is argued to be more crucial in foreign direct investment in banking than in manufacturing (Boldt-Christmas et al, 2001). However, apart from being a tool used to control the activities of banks, regulation also acts as a major incentive for banks to expand abroad. After testing the applicability of various trade theories to international banking, Wengel (1995) found that regulation both motivated and restricted the internationalisation of banks. Boldt-Christmas (2001) also came to the same conclusion after studying the international expansion of Norwegian banks. Slager (2006) identified some ways in which regulation may influence the international activities of banks; Domestic country regulation as incentive to internationalise and regulation controlling the entry and conduct of new foreign banks in the host country.
2.7.6 Historical and cultural determinants
Banks sometimes expand to countries with which they share a common history or culture. This helps to facilitate the integration of the bank to an already unfamiliar territory. Factors like physical and psychic distance largely affect the location decisions of potential multinational banks, considering the fact that different nations may require different marketing strategies and different product designs. Similar administrative systems, culture or language can therefore act as a catalyst to the expansion ambitions of banks into their target markets (Sebastian and Hernansanz, 2000). For instance, a British bank going into a country like Ghana would have less to worry about since English is the Ghanaian national language and coupled with the fact that Ghana was a former British colony, indicating that both countries may still share similar administrative systems. In contrast, a British bank going into Cameroon would have to overcome the language barrier before attending to other issues, as French is the official language of Cameroon and also the chances of both countries having similar administrative systems are low, giving that Cameroon was colonised by the French. According to Ghemawat (2001) colony-colonizer relationships between nations boosts trade by 900%. The familiarity with foreign cultures has had a huge impact on the foreign expansion patterns of early multinational banking. For example, similarity in official language was an important factor in the expansion of American banks to the UK in the mid-twentieth century (Roberts and Arnander 2001, as cited in Slager, 2006). According to Jones (1990) imperial connections were an important factor that determined the direction of nineteenth century multinational banking. For example British banks went to their colonies in various regions like Africa and Australia. However, Cassis (1990) suggests that the absence of Swiss multinational banks during that period could have been due to the comparatively low presence of Swiss imperialism.
Because culture has a strong impact on human behaviour (Johansson, 2006), and the behaviour of consumers will determine their product preferences, it is necessary for organisations entering new territories to understand the contextual undertone of the environment into which they are entering. Therefore, similarities in cultural and historical factors present a host of advantages when banks are internationalising. Products can be better adapted to consumer needs, for example, a bank entering a developing African country would do better packaging products such as soft loans to support people who want to start their own businesses, rather than offering mortgage products. This is not to suggest that people in such countries shouldn't own homes, but they would rather have a steady flow of income first, before owning a home. While this may be different in some other countries, e.g. in the UK, a mortgage is a more important product.
In doubtful social situations, individuals make decisions contrary to the way they would either in isolation or in situations where they have access to information relevant to a reasonable solution. Hence, in uncertain circumstances people herd unconsciously, while in situations of certainty people are inclined to reason consciously (Prechter and Parker, 2007). Banks are run by people, and these people sometimes have to make difficult decisions which may have an impact on the long-term survival of their organisation. Herding occurs when a bank imitates the actions of its peers (Slager, 2006). The choice of a bank to act based on the decision of other banks to investment in a particular location it initially didn't want to venture into can be described as herding (Bikhchandani and Sharma, 2000). An example of such actions can be found in the case of US banks who started opening branches in locations like London and the Bahamas in reaction to the ability of already established US multinational banks to overcome the challenges of the 1966 and 1969-1970 credit crisis (Huertas, 1990). The direction of trade and capital flows, reduction in communication and transportation costs between banks, including the herding behaviour of banks had a significant impact in the formation of international financial centres like London (Kindleberger, 1974)
2.7.8 Market power and concentration
According to Slager (2006) market power and market concentration can act as a powerful motivation for banks to go abroad in a number of ways; firstly, banks may be encourage to internationalise if they possess a limited share of their domestic banking market in comparison to other banks. In a bid to seek other sources of revenue, banks then look to foreign markets where fewer or no limitations exist. Secondly, the desire of banks to exploit their capabilities in foreign markets, which is in a way similar to the traditional market seeking motivation of internationalisation, may also push banks towards foreign expansion. Another is the possible gains of improved efficiency through mergers and acquisitions, particularly if the merger and acquisition is related to a specialised and international financial service with limited competitors. Fourthly, a bank may extend its product range and geographic reach through diversification, which could also be achieved through mergers and acquisitions. And finally, the more imperfect markets are, the more attractive it becomes for banks to internationalise and exploit the imperfections of such markets. By bypassing market intermediaries, banks improve their efficiency and also strengthen their relationships with their clients (Dicken, 1998).
Multinational banks like other multinational companies can support their decision to enter foreign markets with two main cost advantages: economies of scale and scope.
However, Canals (1993) explains that the existence of scale economies in banking is unlikely. Llewellyn (1999) also supports this argument by adding that research on cost reduction economies has yielded questionable results. The existence of scope economies as an internationalisation incentive for banks has been described by Slager (2006) as "more complex" to identify than scale economies. Nonetheless, however elusive the realisation of these economies may be, they are still regarded as incentives for banks to expand abroad. Slager (2006) suggests that economies of scale and scope can act as internationalisation incentives provided they are better achievable abroad.
2.7.10 Cost of capital
An incentive for international expansion is that banks aim to earn a minimal average income from their overall banking activities. The variation in the cost of capital across countries presents an arbitrage opportunity for banks to exploit by going abroad to countries with low cost of capital to source funds, or countries with high cost of capital to compete for a share of the market by offering lower rates on loans to customers. According to Aliber (1984) banks are able to increase their market share, when their cost of inputs (e.g. cost of capital) is lesser than that of their rivals. Further, a handful of authors cited by Aliber (1984) established that the expansion of foreign banks in the US was due to the surge in the cost of capital to American banks and a reduction in the cost of capital to the foreign banks. Cost of capital has been highlighted as one of the major determinants of Australian banks foreign direct investment activities (Moshirian and Pham, 1999) confirming the theoretical argument of McCauley and Zimmer (1991) pertaining to international cost of capital in banking.
2.7.11 Risk or return diversification
Hymer (1960) argues that "profits in one country may be negatively correlated with profits of anotherâ€¦an investor may be able to achieve greater stability in his profitability by diversifying his portfolio and investing part in each country". This also applies to banks, as they to can simply spread their risks by investing in different countries, in so doing smoothen their overall earnings with revenues earned from the various countries. However, Williams (1997) argues that the portfolio diversification argument hardly validates the need for a physical existence to avoid the exposure to risk. He suggests that rather than having a physical presence in a foreign country, the multinational firm could basically invest in firms in various countries. Though there are other authors like Rugman (1976) and Berger et al (2000) who argue in favour of geographical risk diversification, this incentive to internationalise may be considered as weak. Nevertheless, prospective risk or return diversification must give consideration to other risks associated with entering a foreign country e.g. currency risk and country risk (Shapiro, 1985).
2.7.12 Shareholder return and market value
A basic assumption in investment literature over the years is that the value of the shares of an organisation is determined in a relatively efficient approach; information in its entirety is revealed in the value of equity (Reilly and Brown, 2000). An adjustment in the value of equity indicates that new information has hit the market which eventually triggers a reaction from participants in the stock market, meaning that share holder returns can be affected by numerous factors (Slager, 2006). An empirical study by Alexakis (2007) on the relationship between shareholder returns and the acquisition of domestic and foreign banking sectors by six major Greek banks between 1998 and 2006 showed that a positive correlation exists between acquisitions and shareholder returns. Overtime, numerous valuation techniques have been put forward to identify drivers which could help management improve shareholder returns. Classic examples of such drivers for banks are capital employed, gross income, cash flows, operating expenses, and cost of capital (Davies et al., 2000). Further, Davies et al. (2000), as cited by in Slager) note that only limited evidence exists supporting the correlation between shareholder return and these valuation models.
According to Slager (2006) an increase in returns to shareholder as a motivation for internationalising doesn't mean that banks must increase their revenue by internationalising, rather a reduction in variability of earnings (which internationalisation offers) may be sufficient to drive up share holder value.
2.7.13 Financial Systems
Internationalisation, financial development and financial systems are closely related, and there are essentially three basic financial systems; (a) market oriented financial systems (e.g. the UK ): a major part of banks' key activities are carried out by the capital market, and the allocation process is largely decided by market prices, (b) bank oriented financial system (e.g. France or Germany): though the price process is relevant, banks play a crucial part in the allocation process, and finally, (c) government or institution directed financial system (e.g. Japan): banks are used to achieve government targets. Changes or differences in financial systems may motivate the foreign expansion of banks. For instance, due to the highly competitive nature of market driven financial systems, innovative financial products are developed which can be exported to foreign countries with less competitive markets. While banks located outwith market driven financial systems may internationalise in search of financial innovation. Another proposition is that banks in a government driven financial system may be supported to internationalise by the government (Slager, 2006). A typical example of this is the case of the Japanese government's involvement in the internationalisation of the Yokohama specie bank in 1880 (Tamaki, 1990).
Table 3.3 pg 61
2.8 Organisational forms for multinational banks
When a bank like any other firm makes the decision to institute a physical presence abroad, one of the issues that immediately need to be ironed out is the scope of its operations within the foreign country. And this is closely correlated with the type of representation the bank would have in the foreign country. The basic organisational forms available to a bank when expanding abroad are; representative office (most economical), agency, branch and subsidiary (Blandon, 1998). Others forms include alliances and joint ventures. Due to the difficulty of protecting most banking products through patents or copyrights, other organisational forms like franchising or licensing are not relevant to banks when internationalising (Ursacki & Vertinsky, 1992). Another organisational from which has gained relevance lately is the virtual form of representation. Largely attributed to cost minimisation, this form of (foreign or domestic) representation, though not physical is rapidly gaining popularity in the bank and non-bank business environment. ING Direct, First direct, Egg, and a few others are examples of internet banks.
However, previous studies on this subject propose that various factors influence the type of organisational form a bank may have in a country. Among those highlighted are regulation, the size of the bank, client relationship, relative costs, and the scope of other existing foreign activities (Slager, 2006). A good indicator of a bank's level of commitment in the host country is the organisational form it adopts in the country (Blandon, 1998). Some factors which may have an impact on the physical form a multinational bank would adopt in the host country are discussed below;
Regulatory and legal environment
Host country regulatory requirements like bank capitalisation and taxation may vary across the available organisational forms. For instance, the taxation requirements of a foreign subsidiary may differ from that of a foreign branch. Host countries sometimes prescribe the permissible forms of representation in their national market. For example, foreign banks were only permitted to setup agencies in the US back in the early 19th century (Jones, 1990). On the other hand, home country regulators also play a role in deciding the organisational form multinational banks adopt abroad. This can be ascribed to the inability of the home country regulatory agencies to effectively monitor the activities of the multinational bank. Which could result in them placing restrictions on the type of organisational forms their domestic banks can adopt abroad (Pecchioli, 1983).
Though both host and home countries regulations have a huge impact on the adopted organisational form, the nature of the activities a bank intends to pursue will also determine its choice of organisational form. For example, a representative office isn't permitted to offer retail banking services; therefore the reason for their establishment would be to let the parent bank conduct international merchant banking activities (Hienkel & Levi, 1992). Agencies like representative offices are also not allowed to conduct retail banking activities, although they require a higher level of investment. Both organisational forms may therefore apply to banks with little or no multinational banking experience considering the low level of investment required for their establishment in comparison to branches or subsidiaries. A branch on the other hand, actively takes part in the host country's banking industry and requires a much higher level of investment than the forms mentioned above. Branches are mostly set up to support foreign clients, evade home country regulation or to finance activities cheaply (Slager, 2006). Foreign subsidiaries are different from the other forms in the sense that they are incorporated into the banking market of the host country, and hence can carryout similar activities as domestic banks in the host country. In consequence, the parent bank can develop a wide range of activities (at par with domestic banks) in the host country's banking market (Blandon, 1998). The nature of the organisational form also has an effect on the perception of the bank in its home market, especially for reasonably large banks, since they are believed to have the necessary capital requirements to set up more branches and/or subsidiaries. However, mergers and acquisitions have also been suggested to have a major impact on a bank's multinational banking strategy. This can be attributed to the bank's desire to overcome competition by establishing a major presence in the foreign market, by piggy backing on an already existing bank in the market (Slager, 2006).
The choice of organisational form is also determined by firm level relative costs, which include salaries, rents, and cost of communication (Slager, 2006). Communication costs have a tendency to be high, depending on the level of personal or physical communication required for the banking activities in the host country (Ursacki & Vertinsky, 1992). Hence, except there is little physical distance between the home and host countries, banks that want to gain a share of the market for certain businesses may be forced to establish a branch or subsidiary as an alternative to a representative office. Nonetheless, these costs can be considered on an overall level by analysing other factors like the potential benefits from having a presence in the country or the size of the market (Slager, 2006).
2.9 Challenges of Multinational banking
Over the years of their existence, banks like many other institutions have encountered numerous challenges during the course of conducting their business activities, both locally and internationally. And these challenges have had a major impact in shaping their behaviour when entering new markets. Between 1980 and 2000 four major trends have influenced the internationalisation activities of banks (Mullineux & Murinde, 2003, Smith & Walter, 1997, cited in Slager, 2006).
Changing international role of banks: disintermediation, the increasing role of securities market
Worldwide revolution of the banking industry: deregulation, financial crisis and the changing new monetary paradigms
Emerging economic structure in the EU
Evolution of financial services and products
The trends highlighted above have influenced the conduct of internationally active banks in general, for example, the introduction and implementation of the Basle Accord (an international banking regulation), major financial crisis like the current credit crunch, technological advancement, consolidation in national banking markets, regional integrations, etc. However, some other factors may potentially pose major challenges to banks, particularly those from developing countries such as Nigeria as they expand to other developing countries and more so to highly developed countries. This could be attributed to various factors like the level of development of the banking system in such countries, technological development, country of origin effect, and their international exposure. Below, some of the likely issues that banks from foreign countries may need to overcome are discussed.
2.9.1 Liability of foreignness:
Liability of foreignness refers to incidents that result in a foreign firm either incurring costs domestic firms do not, incurring more costs than domestic firms do, or be denied benefits only domestic firms are eligible to receive (Mezias, 2002). A number of studies conducted on the financial services sector of Europe and the United States have shown that foreign financial firms operating within these countries come across a liability of foreignness that limits their ability to effectively deploy their resources (Berger et al., 2000; Miller and Parkhe, 2002; Miller and Richards, 2002). The notion that foreign firms incur extra costs when operating in unfamiliar territories was first suggested by Hymer (1960, 1976) (Ataullah and Hang, 2004). These extra costs are required to overcome the competitive disadvantage the foreign company has in relation to domestic firms in that environment. Some examples of such disadvantages may include; little or no understanding of the host country economy, culture, politics, industry regulations or laws, and access quality labour. Foreign companies are also open to biased treatment from the consumers, government, and other industry stakeholders of the host country. As a result, it is proposed that in order to conquer this challenge, foreign firms need to arm their outposts with some firm specific advantages, usually in the form of managerial or organisational capabilities (Miller and Parkhe, 2002). Aliber (1970) suggests that the cost of conducting business activities abroad are mainly variable costs, resulting from progressive costs of coordination, tax disadvantages and communication. Ataullah and Hang (2004) argue that the restrictions and biased policies targeted at foreign banks during the period of financial repression may hamper the ability of foreign banks to exploit whichever firm specific advantages they hoped to utilise upon entry to the host country. Further, suggesting that the deregulation of the financial industry in such countries could have considerable implications for foreign banks operating therein. As this would result in the creation of a more competitive and less government driven financial sector, which would provide an unbiased environment allowing foreign banks to maximise their inherent firm specific advantages, thereby enabling them to overcome the liability of foreignness. In agreement, Zaheer et al. (1997) propose that the liability of foreignness may reduce overtime.
Rottig (2007) proposes three time dimensions for the analysis of the liability of foreignness. The first is suggested to be concerned with the resulting costs of the liability of foreignness that are fixed those which are required during entry alone, for example, entry regulatory requirements into specific sectors in a country. Second, are those comprising variable costs which may occur more than once, but reduce as the foreign firm becomes more integrated into the local environment. Finally, costs which may not reduce over time, an example is the bias against foreign firms by consumers, suppliers or the government. And such biases may result in foreign firms incurring more costs than local competitors.
2.9.2 Access to quality human resources
The prevalence of inefficient markets results in differences in factor costs across nations (Bartlett et al., 2008). One of the key costs multinational organisations incur is the cost of labour; this includes the cost of attracting and retaining quality employees. In banking, the role of employees cannot be overemphasised, considering the fact that the industry is a service industry and the effective provision of this service is based on knowledge that has been built overtime about customers (corporate and non-corporate), in order to identify their precise needs and serve those needs. According to Casson (1990), the ability of an organisation to internalise the feedback from past experiences is a crucial factor governing its development. Basically, banking is based on relationships, building maintaining and nurturing the relationship with clients. Therefore, access to the right kind of people with the necessary skills and the ability to retain these people could be a very critical factor in banking, both locally and internationally. This ability may even be more critical internationally, if a bank is following or leading its clients. For instance, Japanese banks found it difficult to staff their international subsidiaries when they were expanding abroad, as the subsidiaries were still serving Japanese firms (Morgan et al, 2003). This reinforces the argument of Casson (1990), that the main source of monopoly gains for a multinational bank is personal contact.
2.9.3 Managing risks in the international arena
Operating in the international banking arena exposes banks to all sorts of risks. A note worthy example of such risks is the potential incidence of international financial crisis. Over the years the banking industry has had its fair share of financial crisis. The international monetary fund (1998) highlights four types of financial crisis; bank crisis, foreign debt crisis, currency crisis, and systemic crisis.
Banking crisis: a situation where actual or potential bank defaults compel banks to suspend internal convertibility of their liabilities
Foreign debt crisis: occurs when a bank cant manage its foreign debts
Currency crisis: occurs when a speculative attack on the currency of a country leads to the devaluation of the currency, or compels authorities to defend the currency by increasing international reserves or interest rates
Systemic crisis: This can occur from the escalation of a banking crisis, spreading over to other sectors in the economy, due to the role of banks in the overall economy.
An example of a financial crisis is the current sub-prime mortgage crisis, which has led to a systemic crisis affecting major world economies resulting in US banks loosing up to half of their market value within 2007-2008 (FT.com, 2008). One important framework to monitor the activities of internationally active banks is the Basle Accord. Central banks from the ten largest economies formed the Basle committee and introduced the Basle Accord in response to the difficulties they faced in monitoring and supervising the activities of banks internationally (Slager, 2006). In 1988, the committee introduced the Basle Capital Accord, which mandated banks to maintain a minimum capital standard measured as a ratio of equity and quasi-equity funding to risk-weighted assets of 8% by the end of that year. This was intended to strengthen financial stability, minimise the direct or indirect costs of government backed deposit guarantees, and to establish a level plain field for banks from different countries (Michael and Perraudin, 1998, cited in Slager, 2006). As a result, banks from various countries suffered major set backs in meeting the requirements, e.g. some US banks withdrew from Europe, Japanese banks had to retreat from the international scene, and many foreign banks had to withdraw from the US (Slager, 2006). In 1999, a new capital adequacy framework was proposed by the Basle committee to substitute the old one and was to be implemented in 2004. This new framework focused on three aspects; minimum capital requirements, the effective use of disclosure to strengthen market discipline, and the supervisory review of banks' internal assessment process and capital adequacy.
2.9.4 Technological capability
Out of all the sub-sectors within the service industry, banks are the most technology demanding (Morris, 1987); this may be due in part to the high labour concentration of the sector. Technology "makes possible new structures, new and organisational and geographical arrangement of economic activities, new products and new processes, while not making particular outcomes inevitable" (Dicken, 1998). The two major technological advancements that have reduced the impact of time and space, important aspects of a firm's internationalisation are; communication and transportation technology (Dicken, 1998).
2.10 Performance and multinational banking
One of the goals of any business organisation is to achieve profitability. Businesses expect to earn returns when they make investments, especially large investments like entering a new market. One of the incentives highlighted in earlier sections is the potential impact of foreign expansion on the profitability of mult