The Role of the Foreign Banks in the 5 EU Member states/Uzsienio Banku Vaidmens 5 Europos Sajungos Valstybese Tyrimas

By Festic, Mejra | Journal of Business Economics and Management, February 2012 | Go to article overview

The Role of the Foreign Banks in the 5 EU Member states/Uzsienio Banku Vaidmens 5 Europos Sajungos Valstybese Tyrimas


Festic, Mejra, Journal of Business Economics and Management


1. Introduction

Most banks in the EU's New Member States (NMS) have been privatised with foreign strategic investors. In most New EU Member States (NMS), majority foreign ownership of banks was allowed after major banking and economic crises in the 90.ties. Banking systems had become unstable due to the lack of hard budget constrains and ordinary risk intermediation. Some recent empirical evidence found that foreign ownership of the banking sector improved restructuring in the NMS (regarding the benefits like improving efficiency in intermediation, introducing hard budget constraints, improving risk management, corporate governance etc.).

On the one hand, globalization provides banks with more opportunities for the diversification of their business strategies (thus reducing the exposure of banks to particular markets) and also with a larger risk diversification, which is arguably an advantage of globalization. On the other hand, the low cost of entry to foreign markets intensifies competition among banks (and other financial agents) and consequently increases their exposure to the risks of international financial shocks.

The relationship between the market share of foreign banks in host economies and the impact of ownership on loan supply has been analyzed during the period of the financial crisis. In our estimates for the Baltic States, Romania and Bulgaria (these economies have been chosen due to a high share of foreign banks and their relative quick entrance in these eastern markets), an evidence for the foreign banks pro-cyclical reaction to changes in the host country's macroeconomic environment has been tried to find. When economic growth in host countries decelerates, the foreign banks in the host country might attempt to stabilize credit supply and may also be encouraged to decelerate the credit supply growth due to increased bad loan performance.

The structure of the paper is as follows: The characteristics of the banking sector and macro environment in the Baltic States, Romania and Bulgaria are summarized in the second chapter. In the third chapter, an overview of empirical literature--regarding the stability of credit supply and the role of foreign banks in host economies--is presented. In the fourth chapter, theoretical background, data explanation, methodology of empirical analysis and results are explained. The implications of the empirical analysis are revisited in the conclusion.

2. The banking sector and the macro environment of the Baltic States, Romania and Bulgaria

The banking sectors in the analysed economies--having undergone similar structural changes over a relatively short period of time--share some common structural characteristics. Two of the defining characteristics in banking sectors are a (considerable) foreign presence with a relatively high concentration. These economies have been chosen due to a high share of foreign banks and their relative quick entrance in these eastern European markets (see Table 1). Foreign banks have significantly contributed to the transformation of the banking sector in these economies, owing partly to the increasing integration of EU banking sectors.

The economies used different strategies for privatization in the 90.ties. While some economies went for the quick sale of their banks to foreign investors, others combined public offerings with management buyouts and some placements with foreign strategic investors (see also: Festic et al. 2010).

While the Estonian and Lithuanian banking sector became truly consolidated, Latvia has remained the exception, with a number of smaller niche banks oriented towards the Russian market. Estonia privatized its last remaining large state-owned banks into foreign hands. The Lithuanian banking sector is considerably smaller and its effectiveness has been lower than in Estonia or Latvia due to state ownership, which lasted longer in Lithuania, and due to the fact that the banks are too risk-averse (Adahl 2006).

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