Foreign-Owned Banks in the United States: Earning Market Share or Buying It?
DeYoung, Robert, Nolle, Daniel E., Journal of Money, Credit & Banking
ANXIETIES ABOUT THE DECLINING INFLUENCE Of U.S. banks in international markets made headlines, and prompted Congressional inquiries, in the late 1980s and early 1990s. More recently, however, concern about U.S. banks, competitiveness overseas has given way to alarm about the growing market share of foreign banks in U.S. markets.(1) By one estimate, foreign banks hold nearly 50 percent of all existing commercial and industrial loans made to U.S. businesses. Moreover, foreign banks made these gains swiftly, more than doubling their share of the U.S. market in the past ten years.
Despite this impressive growth - or perhaps because of it - foreign banks were not particularly profitable. This study investigates the relative profit efficiency of foreign - owned U.S. banks and U.S.-owned banks between 1985 and 1990, years during which foreign bank market share was expanding rapidly. We employ a profit frontier model similar to the one pioneered by Berger, Hancock, and Humphrey (1993), and modify the model so that it is less sensitive to variations in asset size. Our results suggest that foreign-owned U.S. banks were significantly less profit efficient than U.S.-owned banks during this time period. Although there was little difference between the two sets of banks in terms of output efficiency, foreign-owned banks had a distinct disadvantage in terms of input efficiency, a disadvantage primarily driven by excess expenditures on purchased funds. These results imply that foreign-owned banks may have placed growth ahead of profitability, expanding their portfolio of loans faster than their ability to develop the relationships necessary to maintain an accompanying base of core deposits.
1. RECENT PERFORMANCE OF FOREIGN BANKS IN THE UNITED STATES
The share of commercial and industrial (C&I) loans to U.S. businesses held by foreign banks increased dramatically between 1983 and 1993. Using conventional measures, the combined market share held by foreign banks doubled from 14 to 32 percent during the period.(2) Perhaps the most popular explanation for the increase in foreign banks' lending to U.S. businesses is that foreign banks "followed" clients from their home countries into U.S. markets.(3) Having established a presence in the United States, many foreign banks grew their market share by purchasing loans in the secondary market (Calomiris and Carey 1994), or by acquiring existing U.S. banks (Kraus 1995), rather than by originating new loans.
Foreign banks may also have exploited a variety of cost advantages relative to U.S. banks to gain a competitive edge. Zimmer and McCauley (1991) concluded that foreign banks enjoyed cost of capital advantages over U.S.-owned banks. McCauley and Seth (1992) and Terrell (1993) found similar advantages for foreign banks concerning cost of funds. Frankel and Morgan (1992) and Wagster, Cooper, and Kolari (1994) found that differences in cross-country regulatory requirements may have reduced foreign banks' costs relative to U.S. banks.
Given these supposed cost advantages, foreign banks should have been able to gain market share by underpricing U.S. banks,(4) by producing higher-quality services than U.S. banks,(5) or both, and still have maintained profits roughly in line with those earned by U.S.-owned banks. However, both Seth (1992) and Nolle (1995) I found that profit rates at foreign-owned banks operating in the United States lagged behind profit rates for U.S.-owned banks during the past decade. For every year but 1987 (when U.S. money center banks provisioned for problem loans to LDCs), these studies concluded that return on assets (ROA) and return on equity (ROE) at foreign banks were less than that for a group of similar U.S. banks.
Three recent studies suggest that cost inefficiency may explain the low profitability of foreign-owned U. S. banks. Chang, Hasan, and Hunter (1995) estimated a stochastic cost frontier model for a panel of foreign-owned and U. …