Foreign bank ownership and business regulations

Manthos D. DelisSurrey Business School

Georgios P. KouretasAthens University of Economics and Business

Chris TsoumasUniversity of Piraeus

Centre for Financial Risk Analysis-EM Lyon Business School,

Thursday 27 March 2014

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Agenda

Goal and MotivationLiterature reviewDataEmpirical methodologyResultsConclusions

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Goal and motivation Motivation

◦ Entry of foreign banks into local banking markets, a worldwide phenomenon during the last decades that has attracted much attention in the literature.

◦ The depth of this entry has potentially important implications for financial and macroeconomic stability in host countries.

◦ But, what about institutions? Goal

To examine empirically the impact of foreign bank presence on host countries institutions, specifically business regulations

Question of increased importance due to its: Importance for long-run growth Permanent nature

Issue not addressed so far in the literature

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Literature ReviewLehner and Schnitzer (2008, JCE)

study the impact that foreign bank entry has on local banks in two ways: (a) spillover effects for local banks and (b) increasing competition in the local banking market. Findings: An increase in competition has positive welfare effects. Spillovers are less likely to have positive welfare effects the stronger bank competition is.

Clarke, Cull and Peria (2006, JCE) use survey data of firms operating in 35 developing and transition economies. They find that all firms of

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Literature Review any size report that they face lower financing

obstacles in countries with higher levels of foreign bank presence.

Giannetti and Ongena (2012) argue that capital inflows and entry of foreign banks can contribute to the development of a country’s financial system (investment and financial expertise). They find that firms have the same access to credit and ability to invest whether they borrow from a foreign bank or not. Foreign banks benefit all firms indirectly since they increase credit access.

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Literature ReviewSytse, Rejie and Rezaul (SMJ,

2006) they provide evidence that it is important to disaggregate foreign ownership into foreign institutional and foreign corporate shareholders. The main finding show that the impact of institutional investors on firm performance is not-clear.

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DataLarge (unbalanced) panel dataset

◦8 large databases employed◦Annual data◦114 countries (both advanced and

emerging)◦1995-2011 period◦5 distinct dependent variables◦Large array of control variables

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DataDependent variables

Variable Definition Source

Business freedom Measures the efficiency of government regulation of business, and is derived from an array of measurements of the difficulty of starting, operating, and closing a business.

Heritage dataset

Freedom to trade internationally

Measures a wide variety of restraints that affect international exchange: tariffs, quotas, hidden administrative restraints, and controls on exchange rates and capital.

Fraser dataset

Regulations Measures the regulatory environment for a country regarding credit market, labor market and business regulations.

Property rights Measures the degree to which a country’s laws protect private property rights, the quality of enforcement of such laws by the state, and the quality of contract enforcement.

Business regulations

Sub-component of the regulations index, measures the efficiency of government regulation of business (administrative requirements for running a business, bureaucracy costs, procedures for starting a business, bribes and favoritism, licensing restrictions and cost of tax compliance).

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Dependent variables’ characteristics

Heritage’s business freedom: Sample period: 1995-2011 Range: 10 to 100

Fraser’s variables: Sample period: 1995 and 2000-2011 Range: 0 to 10

Higher values indicate more efficient regulations

CorrelationsBusiness freedom

Freedom to trade internationally

RegulationsProperty

rightsBusiness freedom 1.00Freedom to trade internationally

0.57 1.00

Regulations 0.51 0.56 1.00Property rights 0.69 0.60 0.58 1.00Business regulations 0.63 0.58 0.74 0.73

Variable Obs. Mean St. Dev. Min. Max. Business freedom 2,188 65.668 15.015 10 100 Freedom to trade internationally

1,527 7.226 1.26 1.103 9.723

Regulations 1,566 6.679 1.033 2.701 9.3 Property rights 1,535 5.716 1.764 1.4 9.6 Business regulations 1,390 5.957 1.151 2.2 9.5

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Data (cont’d)Explanatory variables (Main model)

Variable Definition Source

Foreign bank presence

(log) Ratio of foreign banks to total banks. A foreign bank is a bank where 50% percent or more of its shares are owned by foreigners (Claessens and van Horen, 2013).

Global Financial Development database

GDP per capita(log) Purchasing Power Parity (PPP) adjusted Gross Domestic Product (GDP) per capita at 2005 constant international $ prices (Chain Series)

Penn World Tables 7.1

GDP growth GDP growth (%)World Development Indicators

Inflation Inflation, GDP deflator (%)

Bank credit to bank deposits

Bank credit to bank deposits (%)Global Financial Development database

Inward FDI flows Inward direct investment flows, as a share of GDP

United Nations Conference on Trade and Development (UNCTAD) statistics

Openness Openness at 2005 constant prices, as a share of GDP Penn World Tables 7.1

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Data (cont’d)Additional explanatory variables (Enhanced model)

Variable Definition SourceDemocracy Polity2 measure of democracy Polity IV database

Sound moneyMeasures the consistency of monetary policy with long-term price stability, and the ease with which other currencies can be used via domestic and foreign bank accounts.

Fraser datasetSize of governmentMeasures the size of government interference with the economy (government consumption, transfers and subsidies, government enterprises and investment, top marginal tax rate)

Institutional variables employed as dependent in other econometric specifications (i.e., freedom to trade internationally, property rights, regulations)

Chief executive party orientation

Measures the chief executive party's orientation with respect to economic policy: Right, for parties that are defined as conservative, Christian democratic, or right-wing (value assigned =1); Center, for parties that are defined as centrist or when party position can best be described as centrist (e.g. party advocates strengthening private enterprise in a social-liberal context) (value assigned=2); Left, for parties that are defined as communist, socialist, social democratic, or left-wing (value assigned=3).

Database of Political Institutions

PluralityDummy variable that takes the value of 1 if legislators are elected using a winner-take-all / first past the post rule and 0 otherwise.

Legal origin and religion dummies Djankov et al., 2007

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Explanatory variables’ characteristicsObs. Mean St. Dev. Min. Max.

(log) Foreign bank presence 1,825 3.36 0.915 0 4.605

(log) GDP per capita 2,160 8.723 1.321 5.62 11.822

GDP growth 2,276 0.042 0.046 -0.18 0.89

Inflation 2,275 0.14 1.251 -0.328 53.995

Bank credit to bank deposits 2,183 99.323 63.941 8.612 898.048

Inward FDI flows 2,236 0 0.001 -0.006 0.007

Openness 2,160 0.827 0.517 0.088 4.33

Democracy 2,199 4.045 6.42 -10 10

Sound money 1,532 7.943 1.689 0 9.9Chief executive party orientation

2,261 -8.403 98.223 -999 3

Plurality 2,239 -77.057 267.68 -999 1

Sample period dictated by foreign bank presence availability (1995-2009)

Foreign bank assets to total bank assets not used because of much shorter time period availability (2004-2009)

No collinearities detected

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Empirical MethodologyThree estimation techniques

1.Pooled OLS

Busreg: measure of business regulations in country i at time t Lagged dependent included to account for possible persistence

FB: foreign bank presence (n takes the values 1 or 2)

Xj: array of variables that may affect business regulations

Legal origin and religion dummies included

• εt: time dummies

Two models:

Main model: Xj includes main macroeconomic variables

Enhanced model: Xj adds institutional and political

characteristics Yet, pooled OLS may not be appropriate when both business

regulations and foreign bank presence are driven by some other underlying economic, political and social forces.

ittjitj

jnititit uXFBBusregaBusreg 11

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2. Panel GMM (Arellano – Bover / Blundel – Bond)To account for:

Endogeneity issues (i.e., reverse causation from business regulations to foreign bank presence)

Countries’ fixed effects Ideal method for large N - small T, as in our case Xj’s instrumented with their lagged values (i.e., L2; L3) FB instrumented with:

Fraser’s Foreign ownership/investment restrictions indexSub-component of the Freedom to trade internationally index, based on the following two Global Competitiveness Report questions: “How prevalent is foreign ownership of companies in your country?”; and “How restrictive are regulations in your country relating to international capital flows?”

Two models (main, enhanced), as in pooled OLS

Empirical Methodology

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3. Treatment effects model (two stage IV model)• First stage:

• FBxit is a dummy with 1 for foreign bank presence and 0 otherwise

• Four distinct dummies employed:1.FB10: 1 if foreign bank presence >=10%2.FB20: 1 if foreign bank presence >=20%3.FB30: 1 if foreign bank presence >=30%4.FB40: 1 if foreign bank presence >=40%

• zit is the instrument used in the panel GMM case

• Second stage:

• It models the response of the countries’ business regulations to foreign bank presence (i.e., the “treatment”) relative to the countries with non-foreign bank presence, which serve as the control group

• n takes values 1, 2 and 3• Busregit-1 accounts for the possible differences in the trend of the

dependent variable between the treated and control groups before the treatment

• System estimation

Empirical Methodology

ititit ezbbFB 10x

nitntnjitj

ititnit uXaBxFaBusregaaBusreg 32110ˆ

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Panel A: Pooled OLS Panel B: GMM

Lagged dependent 0.876*** 0.862*** 0.921*** 0.919*** (64.557) (65.514) (18.687) (18.592)

Foreign bank presencet-2 0.524*** 1.516** (2.849) (2.372)

Foreign bank presencet-1 0.635*** 1.324* (3.722) (1.810)

GDP per capita t-1 1.094*** 1.156*** 0.964* 0.880* (6.674) (7.116) (1.886) (1.864)

GDP growth t-1 -2.348 -2.546 -1.603 -2.373

(-0.756) (-0.784) (-0.343) (-0.562)

Inflation t-1 -0.090** -0.092*** -0.037** -0.027* (-2.357) (-2.783) (-2.171) (-1.666)

Bank credit/Deposits t-1 0.003* 0.003* 0.010*** 0.009* (1.892) (1.900) (2.676) (1.932)

Inward FDI flow t-1 -236.696 -321.710 306.430 276.806 (-0.923) (-1.187) (0.506) (0.410)

Openness t-1 0.216 0.369 -0.735 -0.494

(0.837) (1.439) (-1.277) (-0.700) Diagnostics

Obs. 1,507 1,485 1,543 1,517 No. of countries 110 110 114 114 Adj-Rsq. 0.90 0.89 No of GMM instruments 47 47

AR2 (p-value)

-0.24 -0.55 (0.81) (0.58)

Legal origin and religion dummies

not reported for pooled OLS

Main model – Heritage’s business freedom

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Enhanced model – Heritage’s business freedom Panel A: Pooled OLS Panel B: GMM

Lagged dependent 0.860*** 0.844*** 0.916*** 0.922***Foreign bank presencet-2 0.447** 1.682**Foreign bank presencet-1 0.560*** 1.414GDP per capita t-1 0.847*** 0.883*** 0.859** 0.718**GDP growth t-1 -2.629 -2.666 0.859 -0.186Inflation t-1 0.006 0.024 -0.041 -0.021Bank credit/Deposits t-1 0.003** 0.004** 0.012*** 0.011**Inward FDI flow t-1 -359.220 -411.763 618.835 717.980Openness t-1 0.106 0.255 -0.873 -0.862Democracy t-1 0.019 0.021 0.051 0.040Size of government t-1 0.015 0.037 -0.149 -0.131Property rights t-1 0.135 0.161* -0.023 -0.026Sound money t-1 0.079 0.097 -0.070 -0.037Freedom to trade intern. t-1 0.021 -0.007 -0.271 -0.270Regulations t-1 0.438** 0.466** 0.571* 0.528*Government party orientation t-1 0.000 0.000 -0.002 -0.003Plurality t-1 0.000 0.000 -0.000 0.000

Diagnostics

Obs. 1,440 1,418 1,490 1,464No. of countries 107 107 111 111Adj-Rsq. 0.89 0.88No of GMM instruments 55 55

AR2(p-value)

-0.26 -0.63

(0.79) (0.53)

Legal origin and religion dummies not reported for

pooled OLS

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Treatment effects model – Heritage’s business freedom

Panel A: 1 year ahead Panel B: 2 years ahead Panel C: 3 years ahead

Dependent at t-10.75*** 0.74*** 0.74*** 0.74*** 0.65*** 0.63*** 0.63*** 0.63*** 0.54*** 0.52*** 0.52*** 0.52***

FB dummy 10 at t-8.04 -22.71 -29.89

FB dummy 20 at t12.55 16.29* 17.48*

FB dummy 30 at t6.59 8.61* 9.20**

FB dummy 40 at t4.53 6.05 6.38*

GDP per capita 1.76*** 1.92*** 1.87*** 1.93*** 2.51*** 2.74*** 2.68*** 2.80*** 3.27*** 3.56*** 3.49*** 3.61***

GDP growth -7.91 -6.17 -7.90 -8.16* -13.97* -11.87** -14.08** -14.43** -22.44** -19.28*** -21.71*** -22.81***

Inflation -1.04** -1.04** -0.95* -0.98** -3.19***

-3.14*** -3.12*** -3.22*** -3.82** -3.81*** -3.82*** -3.97***

Bank credit/Deposits 0.00* 0.01** 0.01** 0.01** 0.01* 0.01*** 0.01** 0.01*** 0.01 0.01*** 0.01** 0.01**

Inward FDI flow 667.13* 483.33 450.96 461.66 971.60* 724.63 699.07 710.32 1205.37* 910.94* 897.67* 910.98*

Openness 0.53 0.36 0.45 0.44 0.54 0.30 0.41 0.36 0.64 0.38 0.50 0.41

First stage probit

Foreign ownership-Investment restrictions

-0.04* 0.04** 0.07*** 0.07*** -0.03 0.05** 0.08*** 0.09*** -0.02 0.05*** 0.09*** 0.10***

Constant 1.43*** 0.24* -0.29** -0.70*** 1.36*** 0.15 -0.42*** -0.82*** 1.30*** 0.09 -0.52*** -0.95***

Obs. 1,330 1,330 1,330 1,330 1,228 1,228 1,228 1,228 1,127 1,127 1,127 1,127

Pseudo-Rsq. 0.00 0.00 0.01 0.01 0.00 0.01 0.01 0.01 0.00 0.01 0.01 0.02

Legal origin and religion dummies

not reported

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Main model – Fraser’s variablesDependent variable is Freedom to trade internationally  

Panel A: Pooled OLS Panel B: GMM

Foreign bank presencet-2 0.017 0.376**  

(1.544) (2.076)  

Foreign bank presence t-10.026** 0.448**  (2.168) (2.068)  

DiagnosticsObs. 1,060 967 1,094 997  No. of countries 109 107 114 111  Adj-Rsq. 0.92 0.92  No of GMM instruments 37 34  AR2(p-value)

-0.58(0.56)

-0.72(0.47)

 

Dependent variable is Regulations

Panel A: Pooled OLS Panel B: GMM

Foreign bank presencet-2 0.020 -0.074

(1.306) (-0.969)

Foreign bank presence t-10.021 -0.056

(1.278) (-0.597)Diagnostics  Obs. 1,089 995 1,123 1,025No. of countries 109 107 114 111Adj-Rsq. 0.89 0.88No of GMM instruments 45 41AR2(p-value)

0.53(0.60)

0.62(0.54)

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Main model – Fraser’s variables (cont’d)

Dependent variable is Property rights Panel A: Pooled OLS Panel B: GMM

Foreign bank presencet-2 0.010 0.144

(0.755) (0.943)

Foreign bank presence t-1

0.010 0.177

(0.658) (1.140)Diagnostics  

Obs. 1,063 969 1,097 999No. of countries 109 108 114 112Adj-Rsq. 0.95 0.95No of GMM instruments 37 34AR2(p-value)

1.16(0.24)

1.24(0.22)

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Treatment effects model – Fraser’s Freedom to trade internationally

Panel A: 1 year ahead Panel B: 2 years ahead Panel C: 3 years ahead

FB dummy 10 at t-1.90 -2.85 -5.29

(-1.57) (-1.24) (-0.91)

FB dummy 20 at t1.98* 1.52** 1.61**(1.91) (2.12) (2.31)

FB dummy 30 at t1.37*** 1.05*** 1.09***(2.58) (2.73) (3.00)

FB dummy 40 at t0.88*** 0.74*** 0.76***(3.00) (2.84) (3.08)

First stage probit

Foreign ownership-Investment restrictions

-0.08** 0.08** 0.10*** 0.14*** -0.06 0.10*** 0.13*** 0.17*** -0.04 0.11*** 0.15*** 0.20***(-2.03) (2.30) (3.20) (4.50) (-1.44) (2.66) (3.72) (4.80) (-0.98) (2.82) (4.01) (5.17)

Constant1.77*** 0.13 -0.41* -0.99*** 1.63*** -0.04 -0.65*** -1.22*** 1.51*** -0.18 -0.88*** -1.52***

(6.48) (0.56) (-1.95) (-4.60) (5.52) (-0.15) (-2.72) (-5.00) (4.67) (-0.64) (-3.24) (-5.44)Obs. 828 828 828 828 727 727 727 727 626 626 626 626Pseudo-Rsq. 0.01 0.01 0.01 0.02 0.00 0.01 0.02 0.02 0.00 0.01 0.02 0.03

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Panel A: Pooled OLS Panel B: GMM

Foreign bank presencet-20.034* 0.254(1.870) (1.501)

Foreign bank presencet-10.034* 0.729**(1.736) (2.002)

Diagnostics

Obs. 1,004 911 1,038 941No. of countries 109 107 114 111Adj-Rsq. 0.84 0.83No of GMM instruments 39 36AR2(p-value)

-1.04 -0.31(0.29) (0.76)

Main model – Fraser’s Business regulations

Treatment effects model – Fraser’s Business regulations

Panel A: 1 year ahead Panel B: 2 years ahead Panel C: 3 years ahead

FB dummy 10 at t-4.32** -5.35* -7.87(-2.18) (-1.68) (-1.22)

FB dummy 20 at t6.17 4.54 3.73*

(1.24) (1.52) (1.69)

FB dummy 30 at t3.99* 2.95** 2.25**(1.78) (2.12) (2.31)

B dummy 40 at t2.37*** 1.83*** 1.35***(2.75) (2.99) (2.91)

First stage probit

Foreign ownership-Investment restrictions

-0.11** 0.05 0.07** 0.11*** -0.09* 0.07* 0.09** 0.14*** -0.07 0.08* 0.12*** 0.19***

(-2.46) (1.39) (2.12) (3.40) (-1.85) (1.71) (2.55) (3.83) (-1.31) (1.92) (2.91) (4.39)

Constant1.97*** 0.28 -0.24 -0.83*** 1.81*** 0.14 -0.44* -1.07*** 1.65*** -0.01 -0.67** -1.43***(6.14) (1.16) (-1.05) (-3.61) (5.19) (0.53) (-1.70) (-4.12) (4.27) (-0.03) (-2.29) (-4.76)

Obs. 783 783 783 783 682 682 682 682 580 580 580 580

Pseudo-Rsq. 0.01 0.00 0.01 0.01 0.01 0.00 0.01 0.02 0.00 0.01 0.01 0.02

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Conclusions Foreign bank presence does affect business

regulations, measured by◦ Business freedom (difficulty of starting, operating,

and closing a business)◦ Business regulations (administrative requirements for

running a business, bureaucracy costs, procedures for starting a business, bribes and favoritism, licensing restrictions and cost of tax compliance)

◦ Freedom to trade internationally Evidence for impact 2 and 3 years ahead Impact for foreign bank presence larger than

30%◦ Larger than 20% for freedom to trade internationally

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Thank you for your attention!