Global integration in the banking industry

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

Many observers believe that significant global integration is under way in the banking industry and that, in the coming years, individual banks will expand their reach into many countries. Likewise, these observers expect that many national banking markets will develop large foreign components; as that happens, the nationality of a bank in such a market will matter little to prospective customers. (1)

These forecasts are based on the observation that, over the past two or three decades, many nations have removed important regulatory barriers to international banking. Advances in technology also now allow financial institutions to manage larger information flows across more locations and to evaluate and manage risks at lower costs than ever before. Together, these developments have reduced the costs of supplying banking services across borders. At the same time, growth in the international activities and trade of multinational corporations has increased the demand for services from financial institutions that operate across borders.

Despite these developments, the banking industry appears today to be far from globally integrated, particularly in industrialized countries. For example, the foreign share of bank assets in most industrialized countries remains at or below 10 percent. And although bank consolidation has been intense within industrialized countries, mergers and acquisitions across the borders of these countries have been much less common. (2)

To evaluate more closely the extent to which banking is becoming globally integrated, we study the nationality and international reach of banks that provide financial services across Europe to affiliates of multinational corporations. We examine these affiliates because they are among the customers most likely to demand the services of international banks, and we focus on Europe because barriers to financial integration have been extensively reduced on that continent. A finding that banking integration has advanced little even under such favorable conditions would cast doubt on the prospects for the globalization of banking more generally.

We rely mostly on an extensive, carefully conducted 1996 survey of the short-term banking practices of more than 2,000 European affiliates of multinational corporations. Perhaps surprisingly, we find that close to two-thirds of these affiliates choose a bank headquartered in the nation in which they are operating (a host-nation bank) rather than a bank from their home country or a third nation. Moreover, having chosen a host-nation bank, an affiliate is more likely to select a bank limited to local or regional operations rather than a large bank with global reach.

We also examine time-series data that might reveal the degree to which global integration has increased over the past decade. These data cover European syndicated loans, the ratio of domestic private bank claims to total (domestic plus foreign) bank claims, and the dispersion of nonfinancial goods prices across Europe. In brief, the time-series data show a picture for the current period that is not substantially different from that at the time of the 1996 survey.

These results are consistent with the idea that affiliates value host-nation banks over others because host-nation banks better understand their own market and may possess superior information about local nonfinancial suppliers and customers. Our results also imply that affiliates that have chosen host-nation banks value the more customized and relationship-based services offered by banks with local or regional reach, as opposed to the broad-based services offered by a host-nation bank that has global reach.

Our findings suggest that even as economic forces push toward globalization, the high demand for host-based expertise by bank customers, coupled with the competitive advantages that host-nation banks have in providing this expertise, implies that many banking services could very well remain local. In other words, banking markets need not become much more integrated as the globalization of other economic sectors continues.

FOCUS ON EUROPE

Europe is an ideal setting for studying international integration because its countries have taken a number of steps to reduce regulatory barriers to cross-border banking. These steps are known collectively as the "single market" program. (3) Under this program, the European Commission and the European Union (EU) Council of Ministers established directives intended to guarantee equal regulatory treatment of foreign banks by national authorities, unfettered provision of financial services across borders, home-country control of bank supervision, and home-country implementation of bank solvency requirements. (4) The EU Council also passed regulations to liberalize cross-border capital flows and harmonize regulations across member countries that cover capital adequacy, credit exposure, and banks' participation in nonfinancial activities. Most of these directives had been implemented by the mid-1990s. In 1999, eleven members of the EU also entered into the European Monetary Union (EMU) and began to trade in a single currency, the euro. (5)