Directory UMM :Data Elmu:jurnal:J-a:Journal Of Banking And Finance:Vol25.Issue2.2001:
Journal of Banking & Finance 25 (2001) 317±337
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International investment in ®nancial services
Fariborz Moshirian
*
School of Banking and Finance, The University of New South Wales, Sydney NSW 2052, Australia
Received 27 May 1997; accepted 4 October 1999
Abstract
This paper analyzes and models the signi®cant components of international trade in
®nancial services, namely, foreign direct investment in banking for the US, the UK and
Germany. It distinguishes between banks' activities abroad and FDI in banking by
banks and non-banks. A model for FDI in banking is proposed which contains certain
explanatory variables peculiar to FDI in banking as compared to FDI in manufacturing.
The components of the model of FDI in banking is dierent from those models designed
to explain banks activities abroad. The empirical results of this study of FDI in banking
indicate that bilateral trade, banks' foreign assets, the cost of capital, relative economic
growth, exchange rates and FDI in non-®nance industries are the major determinants of
foreign investment in banking. Ó 2001 Elsevier Science B.V. All rights reserved.
JEL classi®cation: G15; G24
Keywords: Financial services; International banking; Foreign investment; Banks'
foreign assets
1. Introduction
According to the UN World Investment Report (1994), world-wide ¯ows of
foreign direct investment (FDI) have grown at unprecedented rates, to reach a
total out¯ow of $225 billion in 1990 (from an outward stock of $1.7 trillion).
*
Tel.: +61-2-9385-5858; fax: +61-2-9385-6347.
E-mail address: [email protected] (F. Moshirian).
0378-4266/01/$ - see front matter Ó 2001 Elsevier Science B.V. All rights reserved.
PII: S 0 3 7 8 - 4 2 6 6 ( 9 9 ) 0 0 1 2 5 - 9
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F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
The average annual growth rate of FDI has been high between 1987 and 1997
and this growth far exceeded that of merchandise exports and nominal GDP.
One of the major categories of US FDI abroad is FDI in banking. US FDI in
banking has increased ®vefold over the period 1983±1997. Statistical data also
show that German FDI in banking has increased over ®vefold during the
period 1983±1997, while UK FDI in banking has more than tripled during the
same period of time. 1 It is worth noting that for all three countries Europe
remains a primary host for foreign banking expansion, whilst Japan remains
relatively closed. In fact, apart from the continued growth in the number of
foreign banks in Hong Kong and Singapore, Asia still lags behind the developing countries of Latin America as host countries for FDI in banking. This
can be attributed to the delayed and incomplete approach many of the Asian
nations are taking toward ®nancial deregulation.
The growth in FDI in banking has been encouraged by a global trend towards ®nancial deregulation, information and telecommunication advances,
and globalisation of the capital market. Indeed, growth in FDI in banking has
not only provided new opportunities for banks to expand their international
businesses from the home country, but has also allowed them to use FDI in
banking to expand their international activities. As more countries deregulated
their ®nancial markets during the 1980s allowing foreign banks and non-banks
to invest in their banking industry, the study of FDI in banking is more signi®cant than ever before.
Despite the continued increase in international investment in banking during
the 1980s and 1990s, there have been few major studies of US banks' activities
abroad, partly due to the lack of quarterly data on FDI in banking. Researchers
have had to use indirect data related to the assets of foreign branches of US
banks, or the number of foreign branches of US banks to study FDI in banking.
Goldberg and Johnson (1990) who examined those factors which determine the
number of foreign branches of US banks and those factors aecting the assets of
foreign branches of US banks over the period 1972±1985, remains one of the few
and indeed the last major study of US banks' activities abroad. However, the
recent unpublished quarterly data on US FDI in banking has provided an opportunity for researchers to measure both bank and non-bank US foreign investment activities in banking for the ®rst time. Thus, this study is the ®rst study
1
FDI in banking of the United Kingdom and Germany are in the following countries: the UK
(Germany only), Belgium, Denmark, Germany (for the UK only), France, Greece, Ireland, Italy,
Netherlands, Portugal, Spain, Austria, Sweden, Switzerland, Africa, Hong Kong, Brazil, Japan,
Australia, New Zealand, South Africa. The United States not only has FDI in the above countries
but also in the following countries: Norway, Turkey, Argentina, Chile, Columbia, Mexico,
Romania, Nigeria, Israel, India, Indonesia, Malaysia, Philippines, Singapore, South Korea,
Taiwan, Thailand. Note that over 70% of the total FDI in banking from these three countries (i.e.,
the US, the UK and Germany) are to OECD countries.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
319
in US banking which uses data on FDI in banking, in an attempt to measure US
banks' activities abroad over the period 1983±1995. Furthermore, this study is
also the ®rst study to measure FDI in banking for Germany and the UK for which
data on FDI in banking could be obtained. As this study, unlike previous studies
on US banks' activities abroad, applies the most sophisticated econometric
techniques to measure the determinants of US FDI in banking, its empirical
®ndings will be statistically more reliable for interpretation.
The remaining part of the paper is structured as follows: Section 2 discusses
trade in ®nancial services and de®nes banks' foreign assets and FDI in banking, Section 3 proposes various factors which determine FDI in banking;
Section 4 models FDI in banking; Section 5 describes the sources of data and
the methodology used in this paper; Section 6 reports the empirical ®ndings;
and Section 7 makes some concluding remarks.
2. Foreign direct investment in banking versus the assets of US banks foreign
branches
There have been a few empirical studies about the determinants of the
number of US banks' branches and oces abroad. Sagari (1986) analysed the
determinants of US foreign investment in banking. Goldberg and Johnson
(1990) examined those factors which determine the number of foreign branches
of US banks and those factors aecting the assets of foreign branches of US
banks over the period 1972±1985. 2
These studies, as mentioned by Moshirian and Pham (1999), did not measure US FDI in banking abroad, but rather the assets of US banks foreign
branches and the number of branches of US banks abroad. However, there are
at least three major categories of investors who invest in banking abroad: 3
(i) Banks that establish their branches, agencies or subsidiaries in a foreign
country.
2
There have also been some studies of foreign banks in the US. Amongst these studies are the
works of Goldberg and Saunders (1981), Hultman and McGee (1989) and Grosse and Goldberg
(1991). Goldberg and Saunders (1981) consider foreign banks' shares of total US commercial bank
assets, and the number of oces in the US owned by foreign banks as the major dependent
variables. As the purpose of Grosse and Goldberg's study (1991) was to analyze foreign bank
activities in the US with respect to countries of origin, they used the assets of the banks of each of
the foreign countries operating in the US as the dependent variable. Their study also has a good
survey of literature in the area of US banks activities abroad and foreign banks activities in the US.
3
Foreign direct investment (cf. portfolio investment) implies that a person in one country has a
lasting interest in, and a degree of in¯uence over the management of a business enterprise in
another country. According to the US Commerce Department, US foreign direct investment
abroad is ownership or control, directly or indirectly, by a single person (or associated group of
persons) from the US of 10% or more of the voting securities of an incorporated foreign business
enterprise or an equivalent interest in an unincorporated foreign business enterprise.
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F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
(ii) Banks that do not have any physical oce in the foreign country, but are
shareholders of foreign banks (i.e., the name of the acquired banks do not
change). While they may own more than 10% of some foreign banks, they
do not have their own business in the foreign market.
(iii) Non-bank corporations, institutions and individuals who invest in foreign banks, and who own 10 or more percent of these foreign banks.
Using the example of US FDI abroad, the number of foreign oces owned
by US banks may encompass some of the foreign business de®ned above,
however neither the number of oces owned by US banks nor the assets of US
banks' foreign branches fully re¯ect the amount of US FDI in banking. Indeed,
according to the US Direct Investment Abroad: 1989 Benchmark Survey, bank
aliates of non-bank US parents (i.e., category (iii)) accounted for 8% of the
total US FDI abroad in banking in 1989. This ®gure for 1994 was 9.6%. In
the case of category (ii), while the US Department of Commerce acknowledges
the existence of such a speci®c category, it does not distinguish direct acquisitions by banks and partial ownership of foreign banks in its statistics.
Table 2 in Appendix A to this paper reports the signi®cance of the geographical breakdown of the assets of US banks foreign branches, the number of
foreign branches of US banks as well as US FDI in banking abroad. As can be
seen, there is not a strong correlation between these three activities. For instance,
while only about 4% of the assets of US banks foreign branches and 23% of the
number of foreign branches of US banks are located in Latin America, over 36%
of US FDI in banking is made in this region. Similarly, in Europe (excluding
member countries of the EU), while less than 1% of the assets of US foreign
branches are located here, over 10% of US FDI is occurring in this region. The
same discrepancy can be seen in the EU and other regions for which data are
available. These ®gures may reinforce the above three categories where not all
FDI in banking is made by banks which establish their branches and oces
abroad (i.e., category (i), as de®ned above) and hence the assets of US banks
foreign branches abroad may not necessarily re¯ect the full magnitude of FDI in
banking. Thus, given the above discussion and data reported in Table 2, one can
see that data on FDI in banking are quite dierent from data on the assets of
foreign branches of banks or that of the number of foreign branches of banks.
3. Factors contributing to FDI in banking
A number of researchers have studied the determinants of US FDI in
manufacturing abroad and foreign FDI in manufacturing in the US. 4 The
4
For a comprehensive survey of literature on FDI see Agarwal (1980), Grosse (1981), Lizondo
(1990) and Caves (1996).
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
321
major determining factors identi®ed in these studies are: the size of the market
in the host country, relative economic growth, cost of capital, exchange rates,
interest rates and taxes. In addition, Williams (1997) has recently surveyed
various established theories of FDI in the context of multinational banking in
which he discusses major FDI theories such as the international investment
theory, the eclectic theory and the industrial organisation hypothesis. In this
study, similar to the study by Moshirian and Pham (1999) who analysed
Australia's FDI in banking, hypotheses based mainly on the eclectic theory will
be used to estimate FDI in banking. This approach is consistent with the
previous studies of foreign banks' activities cited in this study. However, this
study also uses a new proxy for the cost of capital and new explanatory
variables such as banks' international lending activities and FDI in non-®nance
industries which are dierent than those proxies and variables used by previous
studies of foreign banks' activities abroad. This represents an enrichment of the
traditional literature on the determinants of FDI in banking. Also, the use of
superior data to measure US, UK and German investment in foreign banking
ensures that the selected explanatory variables chosen to test the determinants
of FDI in banking abroad re¯ect those factors aecting both non-bank and
bank investors.
The following factors, based predominantly on the eclectic theory of FDI
have been chosen as describing a model of the determinants of foreign direct
investment in banking: (i) banks' foreign assets, (ii) FDI in non-®nance industries, (iii) bilateral trade, (iv) the size of the foreign banking market, (v) the
cost of capital dierential, (vi) relative economic growth, and (vii) the exchange
rate. The remaining part of this section will discuss the rationale behind including the above factors.
3.1. Banks' foreign assets
One of the most likely factors contributing to the expansion of FDI in
banking is banksÕ foreign assets. Establishing a branch abroad makes the
practice of international lending activities both easier and more eective.
While banksÕ foreign assets (i.e., the banks claim against foreigners) can be
generated both in domestic and foreign markets, the existence of a foreign
branch makes it easier for banks to expand their international lending.
Obviously, a foreign presence could also reduce transaction costs (including
telecommunication costs, information gathering and processing costs) and
further facilitate the expansion of international lending. Banks' foreign assets
have not been used by previous researchers as an independent variable for
measuring banks' activities abroad. This is because the previous studies,
such as Goldberg and Johnson (1990) and Grosse and Goldberg (1991), did
not distinguish between the US banks' foreign assets and the US banks'
assets in their foreign branches. This distinction is important in this study,
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F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
as unlike previous studies in banks' foreign activities, the dependent variable
used in this study is FDI in banking rather than US banks' assets in their
foreign branches. 5 Thus, it is hypothesised that the larger a countryÕs banksÕ
foreign assets, the greater will be the size of that countryÕs FDI in banking
abroad.
3.2. FDI in non-®nance industries
It has been argued by researchers such as Grubel (1977) and Gray and
Gray (1981) that there is a positive relationship between FDI in manufacturing and the expansion of banks abroad. Researchers such as Nigh et al.
(1986) and Goldberg and Johnson (1990) found a positive relationship between the US banksÕ foreign activities (including activities with US citizens
abroad and foreign customers) and the size of US FDI. The rationale for this
is that multinational banks will follow their multinational manufacturers
abroad so that they can provide services for their customersÕ foreign operations.
Unlike previous studies on banksÕ activities abroad, this study has access to
both FDI in general less FDI in banking and ®nance and data on FDI in
banking. Thus, as the dependent variable in this study is FDI in banking, the
independent variable used to capture the so called ``gravitational pull eect'' is
total FDI of country i less FDI in banking and ®nance. Thus, the hypothesis to
be tested is whether FDI in banking is positively related to FDI in country i less
FDI in banking and ®nance.
3.3. Bilateral trade
Empirical studies such as Roemer (1975) and Agarwal (1980) on the relationship between general FDI and foreign trade indicate a positive relationship
5
Table 3 in Appendix A to this paper reports the size of the US banks' assets in their foreign
branches, from 1972±1985 (the period for which Goldberg and Johnson (1990) measured US banks'
activities abroad) and was compiled by Houpt (1988). These data sets are compared with the US
banks' foreign assets reported by the IMF Balance of Payments Statistics. As can be seen there is a
signi®cant discrepancy between these two data sets as they are representing two dierent things.
According to the IMF de®nition of banks' foreign assets provided by Landell-Mills (1986), the US
banks' foreign assets are de®ned as those assets held against non-US citizens, which can be
generated both within the United States economy and outside the United States. However, the US
banks have foreign branches in various countries, particularly in countries where US multinational
corporations are operating. Some parts of the assets of US banks' branches and aliates abroad
are held by US companies. In other words, the US banks' activities abroad are comprised of
activities with US individuals and companies abroad as well as with foreign individuals and
companies.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
323
between them. Furthermore Jain (1986) found that, in a sample of 46 countries,
the USÕ share of total trade was highly correlated with its share of banking
assets in these countries. Furthermore, Nigh et al. (1986) found a positive relationship between trade and foreign banksÕ activities.
In this study, similar to previous studies of foreign banking activities, one of
the hypotheses to be tested is a relationship between FDI in banking and bilateral trade for the three countries studied. In order to calculate the trade
variable the following steps have been taken: if we take the US as the example,
the relevant variable has been constructed as the weighted average of bilateral
exports and imports between the US and her trading partners. The weight
given to the sum of exports and imports with a given trading partner is given by
that countryÕs share of US FDI in banking. 6 Given past empirical research on
the eects of international trade on banking and the expectation that increased
foreign trade will encourage trade ®nancing, a positive coecient is expected
for the bilateral trade variable.
3.4. Size of the foreign banking market
When investors (banks and non-banks) consider whether to invest in foreign
banking, the size of the particular foreign banking market is likely to be one of
the factors they take into account. This claim is supported by Kravis and
Lipsey (1982) and O'Sullivan (1985) who argued that the size of the host
country's market is one of the signi®cant determinants of FDI. The size of the
foreign banking market is therefore proposed as a location-speci®c determinant of FDI in banking. In this study, similar to the study of Grosse and
Goldberg (1991), the size of the foreign banking market is proxied by the
weighted sum of two types of deposits held by the banks in country i: (i) time,
savings and foreign currency deposits, and (ii) demand deposits, where the
weights are given by that country's share of US, UK or German foreign direct
investment in banking.
The larger the foreign banking market, the greater the number of potential
new customers for local banks. In turn, this suggests that there is a greater
number of investors (banks and non-banks) willing to invest in foreign markets
in order to take advantage of the market's potential. If the above were observed, a positive relationship between US, UK and German FDI in banking
and the size of the foreign banking market would be expected.
6
Note that the weights used in this study are calculated from the annual data over 1983±1995
based on the US, the UK and German geographical distributions to each country in which they
have FDI in banking. The weights are constant throughout the sample period.
324
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
3.5. Cost of capital dierential
One of the possible determinants of FDI in banking is the cost of capital in
the host and source countries. The traditional literature on cost of capital,
especially in the banking area (see for example, McCauley and Zimmer, 1989)
de®nes ``cost of capital'' as ``the minimum rate of return investors will require
on their investment''. Furthermore, McCauley and Zimmer (1991) de®ne a
banks' cost of capital for a ®nancial product as ``the spread or fee that allows
the required regulatory capital to earn the rate of return demanded by the
market''. Taxes are another of the most likely variables in¯uencing the level of
FDI in banking in a country. The tax regime in use will determine whether
or not a country is an attractive location for private investors to establish part
of their foreign operations.
Thus, the tax variable should be incorporated into the cost of capital so as to
yield the after-tax cost of capital. This is in line with most studies of international investment, such as Lunn (1980), which does not explicitly consider the
impact of tax on FDI. Even in FDI studies where the primary concern is the
impact of taxation (like Hartman, 1984; Shah and Slemrod, 1991), the empirical analyses still focus on the eects of the after-tax rates of return to
foreigners.
As foreign investors consider the bank cost of capital in their own country as
compared to that of foreign countries, the relative bank cost of capital is an
important factor in determining whether a foreign investor will be willing to
invest in banking abroad, as opposed to banks in her own country. Previous
studies on foreign bank activities such as Goldberg and Saunders (1981) and
Hultman and McGee (1989) used the price±earnings ratio for bank stocks in
the US (annual average) as an indicator of principal purchases of banks' stock.
However, as Poterba (1991) discussed several theoretical and empirical diculties in using the price±earnings ratio as a measure of the cost of equity,
particularly across countries, in this study the cost of capital proposed by
McCauley and Zimmer (1991) will be used as one of the hypotheses contributing to FDI in banking abroad.
McCauley and Zimmer (1991) have shown that once the bank managers
have calculated the cost of equity per bank, they should work out the spread or
fee needed to be charged on individual ®nancial products to cover their equity
costs. In other words, assuming that the spread is set in such a way to satisfy
the required equity cost, one may use the spread (measured as lending rate
minus deposit rate corrected for corporate tax) as a proxy for the cost of equity
for banks.
Assuming that the spread is set in such a way that it satis®es the required
equity cost, one may use the spread (measured as lending rate minus deposit
rate corrected for corporate tax) as a proxy for the cost of capital for banks.
Thus, the larger the spread required by banks in order to cover their cost of
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
325
capital, the less competitive is their position in the international banking
market. In this study, the spread between lending and deposit rates corrected
for corporate tax rates of the US, the UK and Germany vis-a-vis the ``rest-ofthe-world'', will be used as a proxy for the cost of capital dierential of
banks. 7
3.6. Relative economic growth
Some researches have argued that one of the factors contributing to the
expansion of foreign banks activities abroad is strong economic activity in the
host countries. For instance, Hultman and McGee (1989) found a positive
relationship between foreign banksÕ activities in the US and economic growth
in the US. Furthermore, Goldberg and Saunders (1981), Nigh et al. (1986) and
Sabi (1988) found that relative economic growth contributes to the expansion
of foreign banking investment. In this study, similar to the above studies, a
relative economic growth variable is calculated as a ratio of the growth in GDP
of the US, the UK or Germany over the weighted average growth in GDP of
those countries in which these three countries invest in banking. A positive
relationship indicates that an increase in relative economic growth expands
FDI in banking abroad more than it does domestic investment in banking.
However, a negative relationship implies that an increase in relative economic
growth makes investment in domestic banking more likely than FDI in
banking abroad.
7
Note that when the bank cost of capital was calculated for the period after 1992, the
calculations were slightly dierent than the spread minus corporate tax used in the previous
quarters due to the so-called Basle agreement. The equation used for the post 1992 calculations is
based on the spread, in which the overall requirement of 4% equity (the Basle Agreement risk
weights, where risk weight for a corporate loan is 100%) is taken into account. As McCauley and
Zimmer (1991) argued, banks are funding 4% of the loan with shareholder equity. The payment to
equity is for the spread on the loan plus the real (net of in¯ation) after-tax return earned by
investing the shareholder equity in a riskless asset. Thus instead of using
S 1 ÿ tc1 COE RW 0:04, the following equation is used to calculate the spread for the
years post 1992 when the Basle agreement was in place:
0:96S 1 ÿ tct 0:04f1 rt 1 ÿ tct g= 1 ps ÿ 1 COE RW 0:04;
where S is the spread between lending and deposit rates, tct the marginal corporate income tax rate
at time t, rt the riskless nominal interest rate at time t, ps the in¯ation rate at time t, COE the cost of
equity, and RW is the risk weighting. As can be seen from the above two equations, the dierence
between the cost of capital calculated prior to 1992 and that calculated post 1992 is very small.
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F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
3.7. Exchange rate
Given that foreign private investors' operations may involve substantial
¯ows of diverse foreign currencies, exchange rates are expected to have an
impact on their FDI decisions in banking.
One possible explanation for a positive correlation between the exchange
rate and FDI in banking abroad may be found in the valuation by investors of
their foreign banking assets in the host countries' currencies. Hultman and
McGee (1989) argued that given a standard accounting practice is to adjust the
book value of nondomestic assets to re¯ect changes in the exchange rate,
foreign investors may expect that any investment they make in the host
countries will appreciate as the local currencies appreciate. On the other hand,
it could be argued that such behavior is more likely for short term liquid assets.
The book value of long term assets should be less prone to such ¯uctuations.
Extending this argument, one would expect a negative correlation between the
value of the host countries' currencies and FDI in banking by the US, the UK
and Germany. When the host countries' currencies appreciate with respect to
foreign investorsÕ currencies, FDI in the US is expected to decrease as it becomes more expensive for foreign investors to invest in those countries, and
vice versa. In other words, a depreciated domestic currency will give foreigners
an edge in acquiring the control of domestic productive assets. Such a negative
correlation is reported by authors such as Goldberg and Saunders (1981),
Cushman (1988) and Froot and Stein (1991). Note also that, as the host
countries' currencies depreciate, private investors may reduce their repatriated
income and increase their reinvestment in the host countries, as they may want
to avoid exchange rate losses. Thus, the hypothesis to be tested is whether
¯uctuations in the value of the host countries' currencies aect the level of FDI
in banking in those countries. 8
A few researchers such as Goldberg and Johnson (1990) have considered
risk as one of the factors aecting FDI. At the same time, the recent study by
Santomero and Babbel (1997) indicates some of the shortcomings of using
proxies to measure ®nancial risk. As mentioned in footnote 1, over 96% and
90% of UK and German FDI in banking, respectively, are in major developed
countries and in the case of the US this ®gure is 80%. Thus, given that the US,
the UK and Germany have such a high proportion of FDI in banking in major
developed countries, country risk would not be a major factor for investment
8
There are several indices available to account for exchange rates. The most appropriate one is
the IMFÕs Multilateral Exchange Rate Model (MERM) index, which is superior to the other indices
available for the purposes of this study. The way the index is constructed implies that an increase in
the US$Õs MERM index indicates an appreciation of the US$ with respect to a weighted basket of
the other currencies.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
327
and hence the comparative risk for investors investing in the form of FDI in
banking will not be considered in this study.
4. A model of foreign direct investment in banking
Based on the previous discussion, the proposed model for US, UK and
German (country i) FDI in banking is as follows:
Xi f BAi ; FDi ; BTi ; CDi ; CCi ; EGi ; EXi :
1
Xi stands for the stock of country iÕs FDI in banking. BAi is the banks' foreign
assets of country i. FDi stands for the stock of country iÕs FDI in non-®nancial
industries, BTi is the weighted average of country iÕs bilateral exports and
imports with her major trading partners. The weight given to each trading
partner is based on country iÕs total FDI in banking in that country. CDi
stands for the weighted average domestic commercial bank deposits for those
countries facing country i's FDI in banking. CCi is the cost of the equity
dierential for banks of country i and those countries facing country i's FDI in
banking. The weight given to each country is based on that country's share of
FDI in banking from country i. EGi stands for the relative economic growth of
country i. The economic growth of countries facing country i's FDI in banking
is calculated as a weighted average of these countries' economic growth. The
weight given to each country is based on country iÕs FDI in banking in that
country. EXi stands for country iÕs MERM index (a measure of the value of
currency i).
The period covered is from 1983:1 to 1995:4, the only period for which data
are available. All variables are expressed in current US$.
In summary, the model for country iÕs FDI in banking can be expressed as
lnXi a0 a1 lnBAi a2 lnFDi a3 lnBTi a4 lnCDi a5 CCi
a6 EGi a7 lnEXi
2
with the following expected signs:
a1 > 0; a2 > 0; a3 > 0; a4 > 0; a5 < 0; a6 ÿ ?; a7 ÿ ?:
5. Data and methodology
The model employed uses time-series quarterly data for the period 1983:1 to
1995:4. Eq. (2) was estimated for the US, the UK and Germany using the data
base IMF International Financial Statistics, various years, from which banks'
foreign assets, exchange rates, bankÕs lending and deposit rates, national in-
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F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
comes, and banksÕ domestic deposits were obtained for all relevant countries.
Tax rates are from publications of the Brookings Institution (edited by Pechman, 1988), the National Bureau of Economic Research (edited by Razin and
Slemrod, 1990), and the OECD Observer Supplement (1996). US, UK and
German bilateral exports and imports were taken from the IMF Directions of
Trade, various issues.
Data on foreign direct investment in banking and non-banking were obtained from the International Division of the US department of Commerce, the
Bank of England Central Statistics Oce, and the Deutsche Bundesbank Statistics Oce (Note that Germany's annual data on various FDI have been used
to construct their quarterly data.) Disaggregated data on foreign direct investment in banking have been obtained, for the US, from the ``Survey of
Current Business'', for the UK, from the ``Bank of England Statistical Abstract'', and for Germany, from the ``Deutsche Bundesbank Zahlungsbilanzstatistics''. Data on general FDI for the US come from the US Department of
Commerce ``Survey of Current Business'', for the UK, from the Central Statistics Oce ``Economic Trends'', and for Germany, from the ``Deutsche Bundesbank Zahlungsbilanzstatistics''.
The Survey of Current Business has published the total FDI abroad for the
US, and total FDI in the US at the market value and the current cost for the
last few years. For instance, the current value of total FDI in the US for 1995
comprises total FDI in the US in 1994 corrected for capital in¯ows, ``price
changes'', ``exchange rate changes'' and ``other changes'' 9 in 1995. However,
unlike the UK and Germany, detailed estimates of FDI in the US by industry
and by country are on a historical-cost basis. As Bargas and Lowe (1994) indicate ``estimates on a historical-cost basis largely re¯ect prices at the time of
investment rather than prices at the current or any other period. Historical cost
is the basis used for the evaluation of company accounting records in the
United States and is the only basis on which companies can report data in the
direct investment surveys conducted by the Bureau of Economic Analysis''. 10
The Survey of Current Business has also published annual data on FDI in
banking in the US since 1980. These data which consist both of book values of
9
``Other changes'' re¯ects changes in the value of the ocial gold stock due to ¯uctuations in the
market price of gold. However, as this item is very small compared to price and exchange rate
changes, this study will not take it into account when converting FDI in banking from book value
to nominal or constant value.
10
Helkie and Stekler (1988) were two of the ®rst researchers to argue that the FDI book values
of US companies abroad and foreign companies in the US are not good economic measures of the
stock of FDI on the ground, and that these values are expressed neither in current nor in constant
dollars, but rather they are historical stock values and hence should be corrected for exchange rate
variations and in¯ation. This study will follow their approach for the correction of the book values
of FDI in banking.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
329
FDI and capital in¯ows of FDI in banking are on a historical-cost basis. Indeed, many studies in FDI used either the book value of FDI or the dierence
between consecutive quarters in FDI as a measure of capital ¯ow (see, for
instance, Cushman, 1988). In this study, the data on the stock of FDI in
banking in the US is converted from being on a historical-cost basis to being in
current values. This ensures that both dependent and independent variables are
compatible with each other. For instance, FDI in banking in the US for 1985:1
is constructed on the basis of the book value of FDI in banking in 1984:4 which
has been corrected for the exchange rate variations and in¯ation of 1985:1. The
result is then added to quarterly capital in¯ows in banking in the quarter
1985:1.
6. Empirical results
The ®rst step in estimating Eq. (2) was to establish whether all variables are
stationary. For this purpose, the Augmented Dicky±Fuller (ADF) and Phillips±Perron unit root tests were employed. The results of these tests showed
that most of the variables for the US, the UK and Germany are non-stationary
and that some of these variables have one unit root. This suggests that the
corresponding ¯ow variables will be stationary. The Augmented Dicky±Fuller
unit root tests applied on the ¯ow variables suggest that all variables are stationary, as can be seen from Table 4 in Appendix A to this paper. Thus, the
¯ow variables in Eq. (2) were used for estimation purposes for the US, the UK
and Germany. Furthermore, as the ¯ow data used in Eq. (2) had random
variations, a moving average with four lags was used to smooth out the volatility of the quarterly data. In addition, Table 5 in Appendix A to this paper
reports the correlation matrix between all the variables in Eq. (2) using the ¯ow
data. As can be seen, the correlation matrix between all variables is low.
As can be seen from previous studies of FDI, almost all these studies used
OLS regression as a means of statistical analysis. However, the empirical results of past studies such as Goldberg and Johnson (1990) and Grosse and
Goldberg (1991) have been subject to statistical problems such as serial correlation, heteroskedasticity and simultaneity bias and hence their results should
have been treated with caution. In order to avoid these statistical problems, the
Generalised Methods of Moments (GMM) is used in this study.
The empirical results show that US, UK and German banksÕ foreign assets
(BAi ) are positively related to FDI in banking. This result indicates that, as the
international lending activities of banks increase, there is an accompanying
increase in their FDI in banking. This result is consistent with the ®ndings of
Moshirian and Pham (1999) for Australia. Thus, while one can argue that US,
UK and German banks' international lending can account for the expansion of
these three countries' FDI in banking, the coecient of this variable is larger
330
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
for Germany than the US and the UK indicating that this variable has greater
in¯uence on FDI in banking in Germany than in the two other countries.
The positive sign between FDI in banking and FDI in the non-®nance industries (FDi ) indicate that FDI in banking and FDI in other industries are
complementary. This empirical result is consistent with the ®ndings of Hultman and McGee (1989) and Goldberg and Johnson (1990) who found a positive relationship between foreign banks activities in the US and the total of
FDI minus FDI in ®nance, insurance and real estate, as an explanatory variable. The t-test for the statistical dierences between the coecients indicated
that the German coecient is greater than that of the UK implying that FDI in
manufacturing has more impacting than on that of the UK.
Bilateral trade (BTi ) variable is found to be positively related to FDI in
banking. This result con®rms the theoretical argument that trade is one of the
contributors of FDI in banking. This result is also consistent with the ®ndings
of Nigh et al. (1986) and Goldberg and Johnson (1990). The test for the statistical dierences between each pair of coecients demonstrates a dierence
between the coecients of the US and Germany, indicating that the trade
variable has a stronger impact on German FDI in banking.
The banks' commercial deposit variable (CDi ) is statistically signi®cant with
a positive sign for the US, the UK and Germany. This result is consistent with
the ®ndings of Grosse and Goldberg (1991) that foreign banks invest in
countries whose domestic banking market is large. Given this result, one could
assume that the host countries' governments have every incentive to increase
domestic savings and deregulate the domestic ®nancial market in an eort to
attract more foreign banks.
As can be seen from Table 1, FDI in banking abroad is negatively related to
the cost of equity dierential (CCi ) for banks between the US, the UK and
Germany and their partner countries. This result implies that an eective and
competitive cost of capital structure by banks contributes to their success when
entering into the foreign banking markets. It is conceivable that banks from the
US, the UK and Germany have access to more diverse markets for capital or a
better credit rating than the banks from the host countries. The size of the
coecient of this variable for the US is much greater than that of the other two
countries. This indicates that the cost of capital dierential has more impact on
the amount of the FDI in banking by the US than the UK and Germany.
The relative economic growth variable (EGi ) is statistically signi®cant with a
negative sign for the US, the UK, Germany. The empirical result shows that as
economic growth in these three countries exceed that of their host countries,
FDI in banking to these host countries declines. In other words, stronger
economic activities in the source countries increase demand for domestic credit
and hence more domestic investment in banking. The size of the coecient of
this variable indicates that German FDI in banking is more aected by relative
economic growth than that of the US or the UK.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
331
Table 1
The empirical results of the foreign direct investment in banking model (1983:1±1995:4)a
US
a
BAi
FDi
BTi
CDi
CCi
EGi
EXi
R2
DW
JBb
WHETc
UK
)0.37 (2.1)
0.04 (11.6)
0.3 (2.1)
0.40 (3.0)
0.008 (4.6)
)13.71 (2.8)
)1.67 (7.0)
)40.5 (2.3)
0.67
1.9
0.80
28.6
Germany
)0.97 ()16.5)
0.013 (20.2)
0.03 (8.0)
0.56 (7.9)
0.005 (4.9)
)0.49 ()11.2)
)1.05 ()7.5)
)81.9 ()4.9)
0.76
1.9
1.8
42.3
)0.44 ()7.4)
0.55 (3.9)
0.19 (5.2)
0.88 (5.4)
0.01 (3.4)
)0.41 ()6.3)
)21.3 ()16.6)
)392 ()5.7)
0.29
1.98
3.4
34.7
a
and indicate that an estimate is signi®cantly dierent from zero at the 5% level and 1% level,
respectively. Student t-statistics are shown in parentheses. GMM: generalised methods of moments.
b
Jacque±Bera test statistic for normality; p value in parentheses.
c
White test for heteroscedasticity.
The empirical results also show that the exchange rate variable for the US,
the UK and Germany (EXi ) has a negative relationship across these countries
with respect to FDI in banking. One could argue that the higher the value of
the currencies of these three countries relative to the currencies of their host
countries, the cheaper it becomes for investors from these three countries to
invest in foreign banking. The size of the coecient of this variable indicates
that UK investors are more responsive in their investment abroad in the wake
of depreciation of the host countries currencies, than the other two countries
studied.
7. Conclusion
This paper has distinguished between banks' activities abroad and FDI in
banking by banks and non-banks. It has argued that the number of oces
owned by banks abroad may correlate to the amount of FDI in banking,
however, it does not include investment by banks who invest in incorporated foreign banks. Furthermore, there are non-bank investors who own
over 10% of some banks in foreign countries, and yet neither the number of
oces owned by banks nor the total assets of banks' branches in foreign
countries fully re¯ect the amount of FDI in banking. A model for FDI in
banking has been proposed which comprises certain explanatory variables
peculiar to FDI in banking as compared to FDI in general and/or FDI in
manufacturing for the US, the UK and Germany. The components of the
model of FDI in banking is dierent from those models designed to explain
332
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
banks activities abroad. The empirical results of this study of FDI in
banking indicate that banks' foreign assets contribute to the expansion of
FDI in banking by both banks and non-bank investors. This result indicates
that while banks could be engaged in international lending activities from
their home countries, access to foreign markets is a very eective way of
expanding their international activities. The empirical results also show a
close link between FDI in banking and FDI in non-®nance sector as well as
between bi-lateral trade. The empirical results support the theoretical argument that those countries with better cost of capital structures, which
have stronger ®nancial positions when competing with the host countries'
banks. Furthermore, this paper has shown that if the economic growth in
the US, the UK and Germany increases faster than that of their host
countries, investors of these three countries tend to invest more in their own
countries rather than in the banking sector of the foreign countries. The
exchange rate appears to be one of the decisive factors in expanding FDI in
banking. As currencies appreciate, there is less incentive for investment in
the foreign banking market. This result implies that both bank and nonbank investors have a long term view of investment in banking and hence
they are not motivated for short term pro®ts.
Given some of the above factors which can be generalized as those factors
that the US, German and British private investors consider as universally
important factors in determining their amount of these three countries' FDI in
banking, one would expect that, with better foreign market access and ``right of
establishment'' for trade in ®nancial services in the ``Post Uruguay Era'' and
successful bilateral trade agreements between the US and Japan, private investors (banks and non-banks) may increase their investment in some nonOECD countries where there is strong economic growth, a high level of FDI in
manufacturing, low cost of capital and rapid expansion of the domestic
banking market.
Acknowledgements
The author would like to thank the two anonymous referees for their
valuable comments and suggestions. The assistance of Alexander Van der Laan
is also gratefully appreciated. However, all errors are mine.
Appendix A
See Tables 2±5.
333
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
Table 2
Comparison of geographical distribution of the assets of US banks foreign branches, the number of
foreign branches of US banks and US FDI in banking in percentagesa
Region
1979
1980
1981
1982
1983
1984
1985
European Union
Ab
Bc
Fd
48
19.3
35
48.5
19
35
47.1
19
30.4
45.9
18.2
39.8
43
17.3
28.5
44.9
17.5
28
46
18.6
31.6
Other Europe
A
B
F
1.11
0.02
10.2
Japan
A
B
F
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
5.1
)0.3
1.6
Other Asia
A
B
F
12
15.8
16
7.9
17.8
9
8.9
17.8
10.2
10.3
19.5
12.4
11.3
0.2
12
12.4
20
11.3
12.6
20
8.5
Latin America
A
B
F
4.3
20
34
4.3
20.4
34.1
4.5
21.5
37.3
4.3
22.5
33
3.3
22.8
34.4
3.3
23.8
37.7
3.4
23.7
3.4
Africa
A
B
F
a
0.004
0.02
1.3
1
0.024
9.7
0.002
0.02
1.7
1.2
0.0221
8.2
0.002
0.02
1.8
0.008
0.02
8
0.002
0.02
1.6
0.009
0.021
10.8
0.059
0.025
9.5
0.007
0.024
11.3
5.5
0.03
1.4
5.6
0.03
1.3
5.4
0.03
1.2
0.002
0.025
1.6
Sources: The Survey of Current Business, various issues and Houpt (1988).
Percentage of the assets of US banks foreign branches.
c
Percentage of the number of foreign branches of US banks.
d
Percentage of US FDI in banking abroad.
b
0.002
0.02
1.6
0.003
0.02
0.15
334
The Assets US banks foreign branches
The US banks' foreign assets
a
1972 1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
77.4 118.0
18.0 23.9
140.5
42.5
162.7
54.7
193.8
72.6
227.9
88.0
257.6
130.0
312.9
156.57
343.5
203.9
391.0
292.8
388.5
401.3
386.1
443.1
337.4
443.3
392.2
446.7
Source: Houpt (1988) and The IMF, Balance of Payment Statistics Yearbook, various annual issues.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
Table 3
Comparison between the assets of US banks foreign branches and US banks' foreign assets (in billions of dollars)a
335
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
Table 4
Augmented Dicky±Fuller statistics for the ¯ow model of Eq. (2)
Variables
s^
US
UK
Germany US
UK
Germany US
UK
Germany
Dx
DBA
DFD
DBT
DCD
DCC
DEG
DEX
)4.6
)4.0
)6.3
)2.3
)3.7
)5.3
)3.6
)4.2
)4.6
)4.1
)9.6
)5.6
)4.1
)5.4
)4.5
)4.5
)4.6
)3.4
)9.6
)4.8
)4.7
)5.5
)3.9
)4.9
)6.9
)4.5
)9.5
)5.8
)3.9
)5.5
)4.9
)3.4
)6.9
)4.4
)9.5
)4.7
)4.8
)5.5
)5.1
)5.6
)7.1
)4.7
)9.4
)5.7
)4.1
)5.4
)4.0
)3.4
)7.1
)4.8
)9.4
)4.8
)4.9
)5.5
)5.1
)5.5
s^T
s^u
)6.9
)4.4
)6.2
)2.9
)3.9
)5.5
)5.1
)5.8
)7.1
)5.0
)6.1
)2.9
)4.4
)5.2
)5.0
)6.0
Table 5
The correlation matrix for the US/Germany/UK using data in Eq. (2)
X
BA
FD
BT
CD
CC
1
0.17
0.37
0.16
0.52
0.03
)0.14
)0.53
1
0.05
)0.22
)0.21
)0.08
)0.03
)0.15
0.1
0.01
)0.35
)0.02
)0.09
)0.28
1
)0.19
)0.17
0.22
)0.08
1
)0.05
)0.09
)0.75
1
)0.22
0.05
1
0.12
1
For Germany
X
1
BA
0.40
FD
0.44
BT
0.17
CD
0.49
CC
0.02
EG
0.09
EX
0.35
1
)0.50
0.29
0.48
)0.2
0.02
0.42
1
0.33
0.72
0.06
0.08
0.56
1
0.36
)0.08
)0.07
0.56
1
)0.04
0.32
0.35
1
)0.13
)0.00
1
)0.09
1
For UK
X
BA
FD
BT
CD
CC
EG
EX
1
)0.14
)0.26
0.13
0.15
)0.44
0.28
1
)0.05
)0.02
)0.28
)0.32
)0.09
1
)0.02
)0.10
)0.02
0.11
1
0.20
)0.35
)0.02
1
0.02
)0.15
1
0.39
1
For US
X
BA
FD
BT
CD
CC
EG
EX
1
0.33
)0.11
0.14
)0.02
0.03
0.51
0.43
EG
EX
336
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
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markets approach. The Quarterly Journal of Economics 106 (4), 1191±1217.
Goldberg, L., Johnson, D., 1990. The determinants of US banking activity abroad. Journal of
International Money and Finance 9, 123±137.
Goldberg, L.G., Saunders, A., 1981. The determinants of foreign banking activity in the US.
Journal of Banking and Finance 5, 17±32.
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www.elsevier.com/locate/econbase
International investment in ®nancial services
Fariborz Moshirian
*
School of Banking and Finance, The University of New South Wales, Sydney NSW 2052, Australia
Received 27 May 1997; accepted 4 October 1999
Abstract
This paper analyzes and models the signi®cant components of international trade in
®nancial services, namely, foreign direct investment in banking for the US, the UK and
Germany. It distinguishes between banks' activities abroad and FDI in banking by
banks and non-banks. A model for FDI in banking is proposed which contains certain
explanatory variables peculiar to FDI in banking as compared to FDI in manufacturing.
The components of the model of FDI in banking is dierent from those models designed
to explain banks activities abroad. The empirical results of this study of FDI in banking
indicate that bilateral trade, banks' foreign assets, the cost of capital, relative economic
growth, exchange rates and FDI in non-®nance industries are the major determinants of
foreign investment in banking. Ó 2001 Elsevier Science B.V. All rights reserved.
JEL classi®cation: G15; G24
Keywords: Financial services; International banking; Foreign investment; Banks'
foreign assets
1. Introduction
According to the UN World Investment Report (1994), world-wide ¯ows of
foreign direct investment (FDI) have grown at unprecedented rates, to reach a
total out¯ow of $225 billion in 1990 (from an outward stock of $1.7 trillion).
*
Tel.: +61-2-9385-5858; fax: +61-2-9385-6347.
E-mail address: [email protected] (F. Moshirian).
0378-4266/01/$ - see front matter Ó 2001 Elsevier Science B.V. All rights reserved.
PII: S 0 3 7 8 - 4 2 6 6 ( 9 9 ) 0 0 1 2 5 - 9
318
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
The average annual growth rate of FDI has been high between 1987 and 1997
and this growth far exceeded that of merchandise exports and nominal GDP.
One of the major categories of US FDI abroad is FDI in banking. US FDI in
banking has increased ®vefold over the period 1983±1997. Statistical data also
show that German FDI in banking has increased over ®vefold during the
period 1983±1997, while UK FDI in banking has more than tripled during the
same period of time. 1 It is worth noting that for all three countries Europe
remains a primary host for foreign banking expansion, whilst Japan remains
relatively closed. In fact, apart from the continued growth in the number of
foreign banks in Hong Kong and Singapore, Asia still lags behind the developing countries of Latin America as host countries for FDI in banking. This
can be attributed to the delayed and incomplete approach many of the Asian
nations are taking toward ®nancial deregulation.
The growth in FDI in banking has been encouraged by a global trend towards ®nancial deregulation, information and telecommunication advances,
and globalisation of the capital market. Indeed, growth in FDI in banking has
not only provided new opportunities for banks to expand their international
businesses from the home country, but has also allowed them to use FDI in
banking to expand their international activities. As more countries deregulated
their ®nancial markets during the 1980s allowing foreign banks and non-banks
to invest in their banking industry, the study of FDI in banking is more signi®cant than ever before.
Despite the continued increase in international investment in banking during
the 1980s and 1990s, there have been few major studies of US banks' activities
abroad, partly due to the lack of quarterly data on FDI in banking. Researchers
have had to use indirect data related to the assets of foreign branches of US
banks, or the number of foreign branches of US banks to study FDI in banking.
Goldberg and Johnson (1990) who examined those factors which determine the
number of foreign branches of US banks and those factors aecting the assets of
foreign branches of US banks over the period 1972±1985, remains one of the few
and indeed the last major study of US banks' activities abroad. However, the
recent unpublished quarterly data on US FDI in banking has provided an opportunity for researchers to measure both bank and non-bank US foreign investment activities in banking for the ®rst time. Thus, this study is the ®rst study
1
FDI in banking of the United Kingdom and Germany are in the following countries: the UK
(Germany only), Belgium, Denmark, Germany (for the UK only), France, Greece, Ireland, Italy,
Netherlands, Portugal, Spain, Austria, Sweden, Switzerland, Africa, Hong Kong, Brazil, Japan,
Australia, New Zealand, South Africa. The United States not only has FDI in the above countries
but also in the following countries: Norway, Turkey, Argentina, Chile, Columbia, Mexico,
Romania, Nigeria, Israel, India, Indonesia, Malaysia, Philippines, Singapore, South Korea,
Taiwan, Thailand. Note that over 70% of the total FDI in banking from these three countries (i.e.,
the US, the UK and Germany) are to OECD countries.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
319
in US banking which uses data on FDI in banking, in an attempt to measure US
banks' activities abroad over the period 1983±1995. Furthermore, this study is
also the ®rst study to measure FDI in banking for Germany and the UK for which
data on FDI in banking could be obtained. As this study, unlike previous studies
on US banks' activities abroad, applies the most sophisticated econometric
techniques to measure the determinants of US FDI in banking, its empirical
®ndings will be statistically more reliable for interpretation.
The remaining part of the paper is structured as follows: Section 2 discusses
trade in ®nancial services and de®nes banks' foreign assets and FDI in banking, Section 3 proposes various factors which determine FDI in banking;
Section 4 models FDI in banking; Section 5 describes the sources of data and
the methodology used in this paper; Section 6 reports the empirical ®ndings;
and Section 7 makes some concluding remarks.
2. Foreign direct investment in banking versus the assets of US banks foreign
branches
There have been a few empirical studies about the determinants of the
number of US banks' branches and oces abroad. Sagari (1986) analysed the
determinants of US foreign investment in banking. Goldberg and Johnson
(1990) examined those factors which determine the number of foreign branches
of US banks and those factors aecting the assets of foreign branches of US
banks over the period 1972±1985. 2
These studies, as mentioned by Moshirian and Pham (1999), did not measure US FDI in banking abroad, but rather the assets of US banks foreign
branches and the number of branches of US banks abroad. However, there are
at least three major categories of investors who invest in banking abroad: 3
(i) Banks that establish their branches, agencies or subsidiaries in a foreign
country.
2
There have also been some studies of foreign banks in the US. Amongst these studies are the
works of Goldberg and Saunders (1981), Hultman and McGee (1989) and Grosse and Goldberg
(1991). Goldberg and Saunders (1981) consider foreign banks' shares of total US commercial bank
assets, and the number of oces in the US owned by foreign banks as the major dependent
variables. As the purpose of Grosse and Goldberg's study (1991) was to analyze foreign bank
activities in the US with respect to countries of origin, they used the assets of the banks of each of
the foreign countries operating in the US as the dependent variable. Their study also has a good
survey of literature in the area of US banks activities abroad and foreign banks activities in the US.
3
Foreign direct investment (cf. portfolio investment) implies that a person in one country has a
lasting interest in, and a degree of in¯uence over the management of a business enterprise in
another country. According to the US Commerce Department, US foreign direct investment
abroad is ownership or control, directly or indirectly, by a single person (or associated group of
persons) from the US of 10% or more of the voting securities of an incorporated foreign business
enterprise or an equivalent interest in an unincorporated foreign business enterprise.
320
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
(ii) Banks that do not have any physical oce in the foreign country, but are
shareholders of foreign banks (i.e., the name of the acquired banks do not
change). While they may own more than 10% of some foreign banks, they
do not have their own business in the foreign market.
(iii) Non-bank corporations, institutions and individuals who invest in foreign banks, and who own 10 or more percent of these foreign banks.
Using the example of US FDI abroad, the number of foreign oces owned
by US banks may encompass some of the foreign business de®ned above,
however neither the number of oces owned by US banks nor the assets of US
banks' foreign branches fully re¯ect the amount of US FDI in banking. Indeed,
according to the US Direct Investment Abroad: 1989 Benchmark Survey, bank
aliates of non-bank US parents (i.e., category (iii)) accounted for 8% of the
total US FDI abroad in banking in 1989. This ®gure for 1994 was 9.6%. In
the case of category (ii), while the US Department of Commerce acknowledges
the existence of such a speci®c category, it does not distinguish direct acquisitions by banks and partial ownership of foreign banks in its statistics.
Table 2 in Appendix A to this paper reports the signi®cance of the geographical breakdown of the assets of US banks foreign branches, the number of
foreign branches of US banks as well as US FDI in banking abroad. As can be
seen, there is not a strong correlation between these three activities. For instance,
while only about 4% of the assets of US banks foreign branches and 23% of the
number of foreign branches of US banks are located in Latin America, over 36%
of US FDI in banking is made in this region. Similarly, in Europe (excluding
member countries of the EU), while less than 1% of the assets of US foreign
branches are located here, over 10% of US FDI is occurring in this region. The
same discrepancy can be seen in the EU and other regions for which data are
available. These ®gures may reinforce the above three categories where not all
FDI in banking is made by banks which establish their branches and oces
abroad (i.e., category (i), as de®ned above) and hence the assets of US banks
foreign branches abroad may not necessarily re¯ect the full magnitude of FDI in
banking. Thus, given the above discussion and data reported in Table 2, one can
see that data on FDI in banking are quite dierent from data on the assets of
foreign branches of banks or that of the number of foreign branches of banks.
3. Factors contributing to FDI in banking
A number of researchers have studied the determinants of US FDI in
manufacturing abroad and foreign FDI in manufacturing in the US. 4 The
4
For a comprehensive survey of literature on FDI see Agarwal (1980), Grosse (1981), Lizondo
(1990) and Caves (1996).
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
321
major determining factors identi®ed in these studies are: the size of the market
in the host country, relative economic growth, cost of capital, exchange rates,
interest rates and taxes. In addition, Williams (1997) has recently surveyed
various established theories of FDI in the context of multinational banking in
which he discusses major FDI theories such as the international investment
theory, the eclectic theory and the industrial organisation hypothesis. In this
study, similar to the study by Moshirian and Pham (1999) who analysed
Australia's FDI in banking, hypotheses based mainly on the eclectic theory will
be used to estimate FDI in banking. This approach is consistent with the
previous studies of foreign banks' activities cited in this study. However, this
study also uses a new proxy for the cost of capital and new explanatory
variables such as banks' international lending activities and FDI in non-®nance
industries which are dierent than those proxies and variables used by previous
studies of foreign banks' activities abroad. This represents an enrichment of the
traditional literature on the determinants of FDI in banking. Also, the use of
superior data to measure US, UK and German investment in foreign banking
ensures that the selected explanatory variables chosen to test the determinants
of FDI in banking abroad re¯ect those factors aecting both non-bank and
bank investors.
The following factors, based predominantly on the eclectic theory of FDI
have been chosen as describing a model of the determinants of foreign direct
investment in banking: (i) banks' foreign assets, (ii) FDI in non-®nance industries, (iii) bilateral trade, (iv) the size of the foreign banking market, (v) the
cost of capital dierential, (vi) relative economic growth, and (vii) the exchange
rate. The remaining part of this section will discuss the rationale behind including the above factors.
3.1. Banks' foreign assets
One of the most likely factors contributing to the expansion of FDI in
banking is banksÕ foreign assets. Establishing a branch abroad makes the
practice of international lending activities both easier and more eective.
While banksÕ foreign assets (i.e., the banks claim against foreigners) can be
generated both in domestic and foreign markets, the existence of a foreign
branch makes it easier for banks to expand their international lending.
Obviously, a foreign presence could also reduce transaction costs (including
telecommunication costs, information gathering and processing costs) and
further facilitate the expansion of international lending. Banks' foreign assets
have not been used by previous researchers as an independent variable for
measuring banks' activities abroad. This is because the previous studies,
such as Goldberg and Johnson (1990) and Grosse and Goldberg (1991), did
not distinguish between the US banks' foreign assets and the US banks'
assets in their foreign branches. This distinction is important in this study,
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F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
as unlike previous studies in banks' foreign activities, the dependent variable
used in this study is FDI in banking rather than US banks' assets in their
foreign branches. 5 Thus, it is hypothesised that the larger a countryÕs banksÕ
foreign assets, the greater will be the size of that countryÕs FDI in banking
abroad.
3.2. FDI in non-®nance industries
It has been argued by researchers such as Grubel (1977) and Gray and
Gray (1981) that there is a positive relationship between FDI in manufacturing and the expansion of banks abroad. Researchers such as Nigh et al.
(1986) and Goldberg and Johnson (1990) found a positive relationship between the US banksÕ foreign activities (including activities with US citizens
abroad and foreign customers) and the size of US FDI. The rationale for this
is that multinational banks will follow their multinational manufacturers
abroad so that they can provide services for their customersÕ foreign operations.
Unlike previous studies on banksÕ activities abroad, this study has access to
both FDI in general less FDI in banking and ®nance and data on FDI in
banking. Thus, as the dependent variable in this study is FDI in banking, the
independent variable used to capture the so called ``gravitational pull eect'' is
total FDI of country i less FDI in banking and ®nance. Thus, the hypothesis to
be tested is whether FDI in banking is positively related to FDI in country i less
FDI in banking and ®nance.
3.3. Bilateral trade
Empirical studies such as Roemer (1975) and Agarwal (1980) on the relationship between general FDI and foreign trade indicate a positive relationship
5
Table 3 in Appendix A to this paper reports the size of the US banks' assets in their foreign
branches, from 1972±1985 (the period for which Goldberg and Johnson (1990) measured US banks'
activities abroad) and was compiled by Houpt (1988). These data sets are compared with the US
banks' foreign assets reported by the IMF Balance of Payments Statistics. As can be seen there is a
signi®cant discrepancy between these two data sets as they are representing two dierent things.
According to the IMF de®nition of banks' foreign assets provided by Landell-Mills (1986), the US
banks' foreign assets are de®ned as those assets held against non-US citizens, which can be
generated both within the United States economy and outside the United States. However, the US
banks have foreign branches in various countries, particularly in countries where US multinational
corporations are operating. Some parts of the assets of US banks' branches and aliates abroad
are held by US companies. In other words, the US banks' activities abroad are comprised of
activities with US individuals and companies abroad as well as with foreign individuals and
companies.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
323
between them. Furthermore Jain (1986) found that, in a sample of 46 countries,
the USÕ share of total trade was highly correlated with its share of banking
assets in these countries. Furthermore, Nigh et al. (1986) found a positive relationship between trade and foreign banksÕ activities.
In this study, similar to previous studies of foreign banking activities, one of
the hypotheses to be tested is a relationship between FDI in banking and bilateral trade for the three countries studied. In order to calculate the trade
variable the following steps have been taken: if we take the US as the example,
the relevant variable has been constructed as the weighted average of bilateral
exports and imports between the US and her trading partners. The weight
given to the sum of exports and imports with a given trading partner is given by
that countryÕs share of US FDI in banking. 6 Given past empirical research on
the eects of international trade on banking and the expectation that increased
foreign trade will encourage trade ®nancing, a positive coecient is expected
for the bilateral trade variable.
3.4. Size of the foreign banking market
When investors (banks and non-banks) consider whether to invest in foreign
banking, the size of the particular foreign banking market is likely to be one of
the factors they take into account. This claim is supported by Kravis and
Lipsey (1982) and O'Sullivan (1985) who argued that the size of the host
country's market is one of the signi®cant determinants of FDI. The size of the
foreign banking market is therefore proposed as a location-speci®c determinant of FDI in banking. In this study, similar to the study of Grosse and
Goldberg (1991), the size of the foreign banking market is proxied by the
weighted sum of two types of deposits held by the banks in country i: (i) time,
savings and foreign currency deposits, and (ii) demand deposits, where the
weights are given by that country's share of US, UK or German foreign direct
investment in banking.
The larger the foreign banking market, the greater the number of potential
new customers for local banks. In turn, this suggests that there is a greater
number of investors (banks and non-banks) willing to invest in foreign markets
in order to take advantage of the market's potential. If the above were observed, a positive relationship between US, UK and German FDI in banking
and the size of the foreign banking market would be expected.
6
Note that the weights used in this study are calculated from the annual data over 1983±1995
based on the US, the UK and German geographical distributions to each country in which they
have FDI in banking. The weights are constant throughout the sample period.
324
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
3.5. Cost of capital dierential
One of the possible determinants of FDI in banking is the cost of capital in
the host and source countries. The traditional literature on cost of capital,
especially in the banking area (see for example, McCauley and Zimmer, 1989)
de®nes ``cost of capital'' as ``the minimum rate of return investors will require
on their investment''. Furthermore, McCauley and Zimmer (1991) de®ne a
banks' cost of capital for a ®nancial product as ``the spread or fee that allows
the required regulatory capital to earn the rate of return demanded by the
market''. Taxes are another of the most likely variables in¯uencing the level of
FDI in banking in a country. The tax regime in use will determine whether
or not a country is an attractive location for private investors to establish part
of their foreign operations.
Thus, the tax variable should be incorporated into the cost of capital so as to
yield the after-tax cost of capital. This is in line with most studies of international investment, such as Lunn (1980), which does not explicitly consider the
impact of tax on FDI. Even in FDI studies where the primary concern is the
impact of taxation (like Hartman, 1984; Shah and Slemrod, 1991), the empirical analyses still focus on the eects of the after-tax rates of return to
foreigners.
As foreign investors consider the bank cost of capital in their own country as
compared to that of foreign countries, the relative bank cost of capital is an
important factor in determining whether a foreign investor will be willing to
invest in banking abroad, as opposed to banks in her own country. Previous
studies on foreign bank activities such as Goldberg and Saunders (1981) and
Hultman and McGee (1989) used the price±earnings ratio for bank stocks in
the US (annual average) as an indicator of principal purchases of banks' stock.
However, as Poterba (1991) discussed several theoretical and empirical diculties in using the price±earnings ratio as a measure of the cost of equity,
particularly across countries, in this study the cost of capital proposed by
McCauley and Zimmer (1991) will be used as one of the hypotheses contributing to FDI in banking abroad.
McCauley and Zimmer (1991) have shown that once the bank managers
have calculated the cost of equity per bank, they should work out the spread or
fee needed to be charged on individual ®nancial products to cover their equity
costs. In other words, assuming that the spread is set in such a way to satisfy
the required equity cost, one may use the spread (measured as lending rate
minus deposit rate corrected for corporate tax) as a proxy for the cost of equity
for banks.
Assuming that the spread is set in such a way that it satis®es the required
equity cost, one may use the spread (measured as lending rate minus deposit
rate corrected for corporate tax) as a proxy for the cost of capital for banks.
Thus, the larger the spread required by banks in order to cover their cost of
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
325
capital, the less competitive is their position in the international banking
market. In this study, the spread between lending and deposit rates corrected
for corporate tax rates of the US, the UK and Germany vis-a-vis the ``rest-ofthe-world'', will be used as a proxy for the cost of capital dierential of
banks. 7
3.6. Relative economic growth
Some researches have argued that one of the factors contributing to the
expansion of foreign banks activities abroad is strong economic activity in the
host countries. For instance, Hultman and McGee (1989) found a positive
relationship between foreign banksÕ activities in the US and economic growth
in the US. Furthermore, Goldberg and Saunders (1981), Nigh et al. (1986) and
Sabi (1988) found that relative economic growth contributes to the expansion
of foreign banking investment. In this study, similar to the above studies, a
relative economic growth variable is calculated as a ratio of the growth in GDP
of the US, the UK or Germany over the weighted average growth in GDP of
those countries in which these three countries invest in banking. A positive
relationship indicates that an increase in relative economic growth expands
FDI in banking abroad more than it does domestic investment in banking.
However, a negative relationship implies that an increase in relative economic
growth makes investment in domestic banking more likely than FDI in
banking abroad.
7
Note that when the bank cost of capital was calculated for the period after 1992, the
calculations were slightly dierent than the spread minus corporate tax used in the previous
quarters due to the so-called Basle agreement. The equation used for the post 1992 calculations is
based on the spread, in which the overall requirement of 4% equity (the Basle Agreement risk
weights, where risk weight for a corporate loan is 100%) is taken into account. As McCauley and
Zimmer (1991) argued, banks are funding 4% of the loan with shareholder equity. The payment to
equity is for the spread on the loan plus the real (net of in¯ation) after-tax return earned by
investing the shareholder equity in a riskless asset. Thus instead of using
S 1 ÿ tc1 COE RW 0:04, the following equation is used to calculate the spread for the
years post 1992 when the Basle agreement was in place:
0:96S 1 ÿ tct 0:04f1 rt 1 ÿ tct g= 1 ps ÿ 1 COE RW 0:04;
where S is the spread between lending and deposit rates, tct the marginal corporate income tax rate
at time t, rt the riskless nominal interest rate at time t, ps the in¯ation rate at time t, COE the cost of
equity, and RW is the risk weighting. As can be seen from the above two equations, the dierence
between the cost of capital calculated prior to 1992 and that calculated post 1992 is very small.
326
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
3.7. Exchange rate
Given that foreign private investors' operations may involve substantial
¯ows of diverse foreign currencies, exchange rates are expected to have an
impact on their FDI decisions in banking.
One possible explanation for a positive correlation between the exchange
rate and FDI in banking abroad may be found in the valuation by investors of
their foreign banking assets in the host countries' currencies. Hultman and
McGee (1989) argued that given a standard accounting practice is to adjust the
book value of nondomestic assets to re¯ect changes in the exchange rate,
foreign investors may expect that any investment they make in the host
countries will appreciate as the local currencies appreciate. On the other hand,
it could be argued that such behavior is more likely for short term liquid assets.
The book value of long term assets should be less prone to such ¯uctuations.
Extending this argument, one would expect a negative correlation between the
value of the host countries' currencies and FDI in banking by the US, the UK
and Germany. When the host countries' currencies appreciate with respect to
foreign investorsÕ currencies, FDI in the US is expected to decrease as it becomes more expensive for foreign investors to invest in those countries, and
vice versa. In other words, a depreciated domestic currency will give foreigners
an edge in acquiring the control of domestic productive assets. Such a negative
correlation is reported by authors such as Goldberg and Saunders (1981),
Cushman (1988) and Froot and Stein (1991). Note also that, as the host
countries' currencies depreciate, private investors may reduce their repatriated
income and increase their reinvestment in the host countries, as they may want
to avoid exchange rate losses. Thus, the hypothesis to be tested is whether
¯uctuations in the value of the host countries' currencies aect the level of FDI
in banking in those countries. 8
A few researchers such as Goldberg and Johnson (1990) have considered
risk as one of the factors aecting FDI. At the same time, the recent study by
Santomero and Babbel (1997) indicates some of the shortcomings of using
proxies to measure ®nancial risk. As mentioned in footnote 1, over 96% and
90% of UK and German FDI in banking, respectively, are in major developed
countries and in the case of the US this ®gure is 80%. Thus, given that the US,
the UK and Germany have such a high proportion of FDI in banking in major
developed countries, country risk would not be a major factor for investment
8
There are several indices available to account for exchange rates. The most appropriate one is
the IMFÕs Multilateral Exchange Rate Model (MERM) index, which is superior to the other indices
available for the purposes of this study. The way the index is constructed implies that an increase in
the US$Õs MERM index indicates an appreciation of the US$ with respect to a weighted basket of
the other currencies.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
327
and hence the comparative risk for investors investing in the form of FDI in
banking will not be considered in this study.
4. A model of foreign direct investment in banking
Based on the previous discussion, the proposed model for US, UK and
German (country i) FDI in banking is as follows:
Xi f BAi ; FDi ; BTi ; CDi ; CCi ; EGi ; EXi :
1
Xi stands for the stock of country iÕs FDI in banking. BAi is the banks' foreign
assets of country i. FDi stands for the stock of country iÕs FDI in non-®nancial
industries, BTi is the weighted average of country iÕs bilateral exports and
imports with her major trading partners. The weight given to each trading
partner is based on country iÕs total FDI in banking in that country. CDi
stands for the weighted average domestic commercial bank deposits for those
countries facing country i's FDI in banking. CCi is the cost of the equity
dierential for banks of country i and those countries facing country i's FDI in
banking. The weight given to each country is based on that country's share of
FDI in banking from country i. EGi stands for the relative economic growth of
country i. The economic growth of countries facing country i's FDI in banking
is calculated as a weighted average of these countries' economic growth. The
weight given to each country is based on country iÕs FDI in banking in that
country. EXi stands for country iÕs MERM index (a measure of the value of
currency i).
The period covered is from 1983:1 to 1995:4, the only period for which data
are available. All variables are expressed in current US$.
In summary, the model for country iÕs FDI in banking can be expressed as
lnXi a0 a1 lnBAi a2 lnFDi a3 lnBTi a4 lnCDi a5 CCi
a6 EGi a7 lnEXi
2
with the following expected signs:
a1 > 0; a2 > 0; a3 > 0; a4 > 0; a5 < 0; a6 ÿ ?; a7 ÿ ?:
5. Data and methodology
The model employed uses time-series quarterly data for the period 1983:1 to
1995:4. Eq. (2) was estimated for the US, the UK and Germany using the data
base IMF International Financial Statistics, various years, from which banks'
foreign assets, exchange rates, bankÕs lending and deposit rates, national in-
328
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
comes, and banksÕ domestic deposits were obtained for all relevant countries.
Tax rates are from publications of the Brookings Institution (edited by Pechman, 1988), the National Bureau of Economic Research (edited by Razin and
Slemrod, 1990), and the OECD Observer Supplement (1996). US, UK and
German bilateral exports and imports were taken from the IMF Directions of
Trade, various issues.
Data on foreign direct investment in banking and non-banking were obtained from the International Division of the US department of Commerce, the
Bank of England Central Statistics Oce, and the Deutsche Bundesbank Statistics Oce (Note that Germany's annual data on various FDI have been used
to construct their quarterly data.) Disaggregated data on foreign direct investment in banking have been obtained, for the US, from the ``Survey of
Current Business'', for the UK, from the ``Bank of England Statistical Abstract'', and for Germany, from the ``Deutsche Bundesbank Zahlungsbilanzstatistics''. Data on general FDI for the US come from the US Department of
Commerce ``Survey of Current Business'', for the UK, from the Central Statistics Oce ``Economic Trends'', and for Germany, from the ``Deutsche Bundesbank Zahlungsbilanzstatistics''.
The Survey of Current Business has published the total FDI abroad for the
US, and total FDI in the US at the market value and the current cost for the
last few years. For instance, the current value of total FDI in the US for 1995
comprises total FDI in the US in 1994 corrected for capital in¯ows, ``price
changes'', ``exchange rate changes'' and ``other changes'' 9 in 1995. However,
unlike the UK and Germany, detailed estimates of FDI in the US by industry
and by country are on a historical-cost basis. As Bargas and Lowe (1994) indicate ``estimates on a historical-cost basis largely re¯ect prices at the time of
investment rather than prices at the current or any other period. Historical cost
is the basis used for the evaluation of company accounting records in the
United States and is the only basis on which companies can report data in the
direct investment surveys conducted by the Bureau of Economic Analysis''. 10
The Survey of Current Business has also published annual data on FDI in
banking in the US since 1980. These data which consist both of book values of
9
``Other changes'' re¯ects changes in the value of the ocial gold stock due to ¯uctuations in the
market price of gold. However, as this item is very small compared to price and exchange rate
changes, this study will not take it into account when converting FDI in banking from book value
to nominal or constant value.
10
Helkie and Stekler (1988) were two of the ®rst researchers to argue that the FDI book values
of US companies abroad and foreign companies in the US are not good economic measures of the
stock of FDI on the ground, and that these values are expressed neither in current nor in constant
dollars, but rather they are historical stock values and hence should be corrected for exchange rate
variations and in¯ation. This study will follow their approach for the correction of the book values
of FDI in banking.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
329
FDI and capital in¯ows of FDI in banking are on a historical-cost basis. Indeed, many studies in FDI used either the book value of FDI or the dierence
between consecutive quarters in FDI as a measure of capital ¯ow (see, for
instance, Cushman, 1988). In this study, the data on the stock of FDI in
banking in the US is converted from being on a historical-cost basis to being in
current values. This ensures that both dependent and independent variables are
compatible with each other. For instance, FDI in banking in the US for 1985:1
is constructed on the basis of the book value of FDI in banking in 1984:4 which
has been corrected for the exchange rate variations and in¯ation of 1985:1. The
result is then added to quarterly capital in¯ows in banking in the quarter
1985:1.
6. Empirical results
The ®rst step in estimating Eq. (2) was to establish whether all variables are
stationary. For this purpose, the Augmented Dicky±Fuller (ADF) and Phillips±Perron unit root tests were employed. The results of these tests showed
that most of the variables for the US, the UK and Germany are non-stationary
and that some of these variables have one unit root. This suggests that the
corresponding ¯ow variables will be stationary. The Augmented Dicky±Fuller
unit root tests applied on the ¯ow variables suggest that all variables are stationary, as can be seen from Table 4 in Appendix A to this paper. Thus, the
¯ow variables in Eq. (2) were used for estimation purposes for the US, the UK
and Germany. Furthermore, as the ¯ow data used in Eq. (2) had random
variations, a moving average with four lags was used to smooth out the volatility of the quarterly data. In addition, Table 5 in Appendix A to this paper
reports the correlation matrix between all the variables in Eq. (2) using the ¯ow
data. As can be seen, the correlation matrix between all variables is low.
As can be seen from previous studies of FDI, almost all these studies used
OLS regression as a means of statistical analysis. However, the empirical results of past studies such as Goldberg and Johnson (1990) and Grosse and
Goldberg (1991) have been subject to statistical problems such as serial correlation, heteroskedasticity and simultaneity bias and hence their results should
have been treated with caution. In order to avoid these statistical problems, the
Generalised Methods of Moments (GMM) is used in this study.
The empirical results show that US, UK and German banksÕ foreign assets
(BAi ) are positively related to FDI in banking. This result indicates that, as the
international lending activities of banks increase, there is an accompanying
increase in their FDI in banking. This result is consistent with the ®ndings of
Moshirian and Pham (1999) for Australia. Thus, while one can argue that US,
UK and German banks' international lending can account for the expansion of
these three countries' FDI in banking, the coecient of this variable is larger
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F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
for Germany than the US and the UK indicating that this variable has greater
in¯uence on FDI in banking in Germany than in the two other countries.
The positive sign between FDI in banking and FDI in the non-®nance industries (FDi ) indicate that FDI in banking and FDI in other industries are
complementary. This empirical result is consistent with the ®ndings of Hultman and McGee (1989) and Goldberg and Johnson (1990) who found a positive relationship between foreign banks activities in the US and the total of
FDI minus FDI in ®nance, insurance and real estate, as an explanatory variable. The t-test for the statistical dierences between the coecients indicated
that the German coecient is greater than that of the UK implying that FDI in
manufacturing has more impacting than on that of the UK.
Bilateral trade (BTi ) variable is found to be positively related to FDI in
banking. This result con®rms the theoretical argument that trade is one of the
contributors of FDI in banking. This result is also consistent with the ®ndings
of Nigh et al. (1986) and Goldberg and Johnson (1990). The test for the statistical dierences between each pair of coecients demonstrates a dierence
between the coecients of the US and Germany, indicating that the trade
variable has a stronger impact on German FDI in banking.
The banks' commercial deposit variable (CDi ) is statistically signi®cant with
a positive sign for the US, the UK and Germany. This result is consistent with
the ®ndings of Grosse and Goldberg (1991) that foreign banks invest in
countries whose domestic banking market is large. Given this result, one could
assume that the host countries' governments have every incentive to increase
domestic savings and deregulate the domestic ®nancial market in an eort to
attract more foreign banks.
As can be seen from Table 1, FDI in banking abroad is negatively related to
the cost of equity dierential (CCi ) for banks between the US, the UK and
Germany and their partner countries. This result implies that an eective and
competitive cost of capital structure by banks contributes to their success when
entering into the foreign banking markets. It is conceivable that banks from the
US, the UK and Germany have access to more diverse markets for capital or a
better credit rating than the banks from the host countries. The size of the
coecient of this variable for the US is much greater than that of the other two
countries. This indicates that the cost of capital dierential has more impact on
the amount of the FDI in banking by the US than the UK and Germany.
The relative economic growth variable (EGi ) is statistically signi®cant with a
negative sign for the US, the UK, Germany. The empirical result shows that as
economic growth in these three countries exceed that of their host countries,
FDI in banking to these host countries declines. In other words, stronger
economic activities in the source countries increase demand for domestic credit
and hence more domestic investment in banking. The size of the coecient of
this variable indicates that German FDI in banking is more aected by relative
economic growth than that of the US or the UK.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
331
Table 1
The empirical results of the foreign direct investment in banking model (1983:1±1995:4)a
US
a
BAi
FDi
BTi
CDi
CCi
EGi
EXi
R2
DW
JBb
WHETc
UK
)0.37 (2.1)
0.04 (11.6)
0.3 (2.1)
0.40 (3.0)
0.008 (4.6)
)13.71 (2.8)
)1.67 (7.0)
)40.5 (2.3)
0.67
1.9
0.80
28.6
Germany
)0.97 ()16.5)
0.013 (20.2)
0.03 (8.0)
0.56 (7.9)
0.005 (4.9)
)0.49 ()11.2)
)1.05 ()7.5)
)81.9 ()4.9)
0.76
1.9
1.8
42.3
)0.44 ()7.4)
0.55 (3.9)
0.19 (5.2)
0.88 (5.4)
0.01 (3.4)
)0.41 ()6.3)
)21.3 ()16.6)
)392 ()5.7)
0.29
1.98
3.4
34.7
a
and indicate that an estimate is signi®cantly dierent from zero at the 5% level and 1% level,
respectively. Student t-statistics are shown in parentheses. GMM: generalised methods of moments.
b
Jacque±Bera test statistic for normality; p value in parentheses.
c
White test for heteroscedasticity.
The empirical results also show that the exchange rate variable for the US,
the UK and Germany (EXi ) has a negative relationship across these countries
with respect to FDI in banking. One could argue that the higher the value of
the currencies of these three countries relative to the currencies of their host
countries, the cheaper it becomes for investors from these three countries to
invest in foreign banking. The size of the coecient of this variable indicates
that UK investors are more responsive in their investment abroad in the wake
of depreciation of the host countries currencies, than the other two countries
studied.
7. Conclusion
This paper has distinguished between banks' activities abroad and FDI in
banking by banks and non-banks. It has argued that the number of oces
owned by banks abroad may correlate to the amount of FDI in banking,
however, it does not include investment by banks who invest in incorporated foreign banks. Furthermore, there are non-bank investors who own
over 10% of some banks in foreign countries, and yet neither the number of
oces owned by banks nor the total assets of banks' branches in foreign
countries fully re¯ect the amount of FDI in banking. A model for FDI in
banking has been proposed which comprises certain explanatory variables
peculiar to FDI in banking as compared to FDI in general and/or FDI in
manufacturing for the US, the UK and Germany. The components of the
model of FDI in banking is dierent from those models designed to explain
332
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
banks activities abroad. The empirical results of this study of FDI in
banking indicate that banks' foreign assets contribute to the expansion of
FDI in banking by both banks and non-bank investors. This result indicates
that while banks could be engaged in international lending activities from
their home countries, access to foreign markets is a very eective way of
expanding their international activities. The empirical results also show a
close link between FDI in banking and FDI in non-®nance sector as well as
between bi-lateral trade. The empirical results support the theoretical argument that those countries with better cost of capital structures, which
have stronger ®nancial positions when competing with the host countries'
banks. Furthermore, this paper has shown that if the economic growth in
the US, the UK and Germany increases faster than that of their host
countries, investors of these three countries tend to invest more in their own
countries rather than in the banking sector of the foreign countries. The
exchange rate appears to be one of the decisive factors in expanding FDI in
banking. As currencies appreciate, there is less incentive for investment in
the foreign banking market. This result implies that both bank and nonbank investors have a long term view of investment in banking and hence
they are not motivated for short term pro®ts.
Given some of the above factors which can be generalized as those factors
that the US, German and British private investors consider as universally
important factors in determining their amount of these three countries' FDI in
banking, one would expect that, with better foreign market access and ``right of
establishment'' for trade in ®nancial services in the ``Post Uruguay Era'' and
successful bilateral trade agreements between the US and Japan, private investors (banks and non-banks) may increase their investment in some nonOECD countries where there is strong economic growth, a high level of FDI in
manufacturing, low cost of capital and rapid expansion of the domestic
banking market.
Acknowledgements
The author would like to thank the two anonymous referees for their
valuable comments and suggestions. The assistance of Alexander Van der Laan
is also gratefully appreciated. However, all errors are mine.
Appendix A
See Tables 2±5.
333
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
Table 2
Comparison of geographical distribution of the assets of US banks foreign branches, the number of
foreign branches of US banks and US FDI in banking in percentagesa
Region
1979
1980
1981
1982
1983
1984
1985
European Union
Ab
Bc
Fd
48
19.3
35
48.5
19
35
47.1
19
30.4
45.9
18.2
39.8
43
17.3
28.5
44.9
17.5
28
46
18.6
31.6
Other Europe
A
B
F
1.11
0.02
10.2
Japan
A
B
F
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
5.1
)0.3
1.6
Other Asia
A
B
F
12
15.8
16
7.9
17.8
9
8.9
17.8
10.2
10.3
19.5
12.4
11.3
0.2
12
12.4
20
11.3
12.6
20
8.5
Latin America
A
B
F
4.3
20
34
4.3
20.4
34.1
4.5
21.5
37.3
4.3
22.5
33
3.3
22.8
34.4
3.3
23.8
37.7
3.4
23.7
3.4
Africa
A
B
F
a
0.004
0.02
1.3
1
0.024
9.7
0.002
0.02
1.7
1.2
0.0221
8.2
0.002
0.02
1.8
0.008
0.02
8
0.002
0.02
1.6
0.009
0.021
10.8
0.059
0.025
9.5
0.007
0.024
11.3
5.5
0.03
1.4
5.6
0.03
1.3
5.4
0.03
1.2
0.002
0.025
1.6
Sources: The Survey of Current Business, various issues and Houpt (1988).
Percentage of the assets of US banks foreign branches.
c
Percentage of the number of foreign branches of US banks.
d
Percentage of US FDI in banking abroad.
b
0.002
0.02
1.6
0.003
0.02
0.15
334
The Assets US banks foreign branches
The US banks' foreign assets
a
1972 1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
77.4 118.0
18.0 23.9
140.5
42.5
162.7
54.7
193.8
72.6
227.9
88.0
257.6
130.0
312.9
156.57
343.5
203.9
391.0
292.8
388.5
401.3
386.1
443.1
337.4
443.3
392.2
446.7
Source: Houpt (1988) and The IMF, Balance of Payment Statistics Yearbook, various annual issues.
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
Table 3
Comparison between the assets of US banks foreign branches and US banks' foreign assets (in billions of dollars)a
335
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
Table 4
Augmented Dicky±Fuller statistics for the ¯ow model of Eq. (2)
Variables
s^
US
UK
Germany US
UK
Germany US
UK
Germany
Dx
DBA
DFD
DBT
DCD
DCC
DEG
DEX
)4.6
)4.0
)6.3
)2.3
)3.7
)5.3
)3.6
)4.2
)4.6
)4.1
)9.6
)5.6
)4.1
)5.4
)4.5
)4.5
)4.6
)3.4
)9.6
)4.8
)4.7
)5.5
)3.9
)4.9
)6.9
)4.5
)9.5
)5.8
)3.9
)5.5
)4.9
)3.4
)6.9
)4.4
)9.5
)4.7
)4.8
)5.5
)5.1
)5.6
)7.1
)4.7
)9.4
)5.7
)4.1
)5.4
)4.0
)3.4
)7.1
)4.8
)9.4
)4.8
)4.9
)5.5
)5.1
)5.5
s^T
s^u
)6.9
)4.4
)6.2
)2.9
)3.9
)5.5
)5.1
)5.8
)7.1
)5.0
)6.1
)2.9
)4.4
)5.2
)5.0
)6.0
Table 5
The correlation matrix for the US/Germany/UK using data in Eq. (2)
X
BA
FD
BT
CD
CC
1
0.17
0.37
0.16
0.52
0.03
)0.14
)0.53
1
0.05
)0.22
)0.21
)0.08
)0.03
)0.15
0.1
0.01
)0.35
)0.02
)0.09
)0.28
1
)0.19
)0.17
0.22
)0.08
1
)0.05
)0.09
)0.75
1
)0.22
0.05
1
0.12
1
For Germany
X
1
BA
0.40
FD
0.44
BT
0.17
CD
0.49
CC
0.02
EG
0.09
EX
0.35
1
)0.50
0.29
0.48
)0.2
0.02
0.42
1
0.33
0.72
0.06
0.08
0.56
1
0.36
)0.08
)0.07
0.56
1
)0.04
0.32
0.35
1
)0.13
)0.00
1
)0.09
1
For UK
X
BA
FD
BT
CD
CC
EG
EX
1
)0.14
)0.26
0.13
0.15
)0.44
0.28
1
)0.05
)0.02
)0.28
)0.32
)0.09
1
)0.02
)0.10
)0.02
0.11
1
0.20
)0.35
)0.02
1
0.02
)0.15
1
0.39
1
For US
X
BA
FD
BT
CD
CC
EG
EX
1
0.33
)0.11
0.14
)0.02
0.03
0.51
0.43
EG
EX
336
F. Moshirian / Journal of Banking & Finance 25 (2001) 317±337
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