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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 di€erent 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.Ó2001 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).

www.elsevier.com/locate/econbase

*Tel.: +61-2-9385-5858; fax: +61-2-9385-6347.

E-mail address:f.moshirian@unsw.edu.au (F. Moshirian).

0378-4266/01/$ - see front matterÓ2001 Elsevier Science B.V. All rights reserved.

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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.1It 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 devel-oping 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 to-wards ®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 sig-ni®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 a€ecting 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 op-portunity for researchers to measure both bank and non-bank US foreign in-vestment activities in banking for the ®rst time. Thus, this study is the ®rst study

1

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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 bank-ing, 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 oces 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 a€ecting 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 mea-sure 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.

2There 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 oces 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.

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(ii) Banks that do not have any physical oce 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 for-eign banks, and who own 10 or more percent of these forfor-eign banks. Using the example of US FDI abroad, the number of foreign oces owned by US banks may encompass some of the foreign business de®ned above, however neither the number of oces 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 theUS Direct Investment Abroad: 1989 Benchmark Survey, bank aliates 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 acqui-sitions 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 geo-graphical 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 oces 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 di€erent 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

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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 di€erent 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 a€ecting 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 in-dustries, (iii) bilateral trade, (iv) the size of the foreign banking market, (v) the cost of capital di€erential, (vi) relative economic growth, and (vii) the exchange rate. The remaining part of this section will discuss the rationale behind in-cluding the above factors.

3.1. Banks'foreign assets

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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.5Thus, 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 manufac-turing and the expansion of banks abroad. Researchers such as Nigh et al. (1986) and Goldberg and Johnson (1990) found a positive relationship be-tween 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 opera-tions.

Unlike previous studies on banksÕactivities 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 e€ect'' is total FDI of countryiless FDI in banking and ®nance. Thus, the hypothesis to be tested is whether FDI in banking is positively related to FDI in countryiless FDI in banking and ®nance.

3.3. Bilateral trade

Empirical studies such as Roemer (1975) and Agarwal (1980) on the rela-tionship between general FDI and foreign trade indicate a positive relarela-tionship

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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 re-lationship between trade and foreign banksÕactivities.

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 bi-lateral 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.6Given past empirical research on the e€ects of international trade on banking and the expectation that increased foreign trade will encourage trade ®nancing, a positive coecient 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 determi-nant 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 countryi: (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 ob-served, a positive relationship between US, UK and German FDI in banking and the size of the foreign banking market would be expected.

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3.5. Cost of capital di€erential

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 interna-tional 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 em-pirical analyses still focus on the e€ects 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 di-culties 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 contrib-uting 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.

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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-of-the-world'', will be used as a proxy for the cost of capital di€erential 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.

7Note that when the bank cost of capital was calculated for the period after 1992, the calculations were slightly di€erent 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 …1ÿtc1† ˆCOERW0:04Š, the following equation is used to calculate the spread for the

years post 1992 when the Basle agreement was in place:

0:96S…1ÿtct† ‡0:04f1‡ ‰rt…1ÿtct†Šg=…1‡ps† ÿ1ˆCOERW0:04;

whereSis the spread between lending and deposit rates,tctthe marginal corporate income tax rate

at timet,rtthe riskless nominal interest rate at timet,p

sthe in¯ation rate at timet, COE the cost of

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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 be-comes 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 a€ect 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 a€ecting 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

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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 (countryi) FDI in banking is as follows:

Xiˆf…BAi;FDi;BTi;CDi;CCi;EGi;EXi†: …1†

Xistands for the stock of countryiÕs FDI in banking. BAiis the banks' foreign assets of countryi. FDistands for the stock of countryiÕs 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 di€erential for banks of countryiand those countries facing countryi's FDI in banking. The weight given to each country is based on that country's share of FDI in banking from countryi. EGistands for the relative economic growth of countryi. The economic growth of countries facing countryi's FDI in banking is calculated as a weighted average of these countries' economic growth. The weight given to each country is based on countryiÕs FDI in banking in that country. EXi stands for countryiÕs MERM index (a measure of the value of currencyi).

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 countryiÕs FDI in banking can be expressed as

lnXiˆa0‡a1ln BAi‡a2ln FDi‡a3ln BTi‡a4ln CDi‡a5CCi

‡a6EGi‡a7ln EXi …2†

with the following expected signs:

a1>0;a2>0;a3>0;a4>0;a5<0;a6ÿ?;a7ÿ?:

5. Data and methodology

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in-comes, and banksÕ domestic deposits were obtained for all relevant countries. Tax rates are from publications of the Brookings Institution (edited by Pech-man, 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 IMFDirections of

Trade, various issues.

Data on foreign direct investment in banking and non-banking were ob-tained from theInternational Division of the US department of Commerce, the

Bank of England Central Statistics Oce, and the Deutsche Bundesbank

Sta-tistics Oce(Note that Germany's annual data on various FDI have been used

to construct their quarterly data.) Disaggregated data on foreign direct in-vestment in banking have been obtained, for the US, from the ``Survey of Current Business'', for the UK, from the ``Bank of England Statistical

Ab-stract'', and for Germany, from the ``Deutsche Bundesbank

Zahlungsbilanz-statistics''. Data on general FDI for the US come from the US Department of

Commerce ``Survey of Current Business'', for the UK, from theCentral

Sta-tistics Oce``Economic Trends'', and for Germany, from the ``Deutsche

Bun-desbank Zahlungsbilanzstatistics''.

TheSurvey of Current Businesshas 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''9in 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) in-dicate ``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

TheSurvey 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

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``Other changes'' re¯ects changes in the value of the ocial 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

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FDI and capital in¯ows of FDI in banking are on a historical-cost basis. In-deed, many studies in FDI used either the book value of FDI or the di€erence 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 Phil-lips±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 sta-tionary, 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 vol-atility 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 re-sults of past studies such as Goldberg and Johnson (1990) and Grosse and Goldberg (1991) have been subject to statistical problems such as serial cor-relation, 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 banksÕforeign assets (BAi) are positively related to FDI in banking. This result indicates that, as the

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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 in-dustries (FDi) indicate that FDI in banking and FDI in other industries are

complementary. This empirical result is consistent with the ®ndings of Hult-man and McGee (1989) and Goldberg and Johnson (1990) who found a pos-itive relationship between foreign banks activities in the US and the total of FDI minus FDI in ®nance, insurance and real estate, as an explanatory vari-able. Thet-test for the statistical di€erences between the coecients indicated that the German coecient 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 sta-tistical di€erences between each pair of coecients demonstrates a di€erence between the coecients 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 e€ort to attract more foreign banks.

As can be seen from Table 1, FDI in banking abroad is negatively related to the cost of equity di€erential (CCi) for banks between the US, the UK and

Germany and their partner countries. This result implies that an e€ective 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 coecient of this variable for the US is much greater than that of the other two countries. This indicates that the cost of capital di€erential 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

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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 coecient 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 oces owned by banks abroad may correlate to the amount of FDI in banking, however, it does not include investment by banks who invest in incorpo-rated foreign banks. Furthermore, there are non-bank investors who own over 10% of some banks in foreign countries, and yet neither the number of oces 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 di€erent from those models designed to explain

Table 1

The empirical results of the foreign direct investment in banking model (1983:1±1995:4)a

US UK Germany

a )0.37(2.1) )0.97()16.5) )0.44()7.4)

BAi 0.04(11.6) 0.013(20.2) 0.55(3.9)

FDi 0.3(2.1) 0.03(8.0) 0.19(5.2)

BTi 0.40(3.0) 0.56 (7.9) 0.88(5.4)

CDi 0.008(4.6) 0.005(4.9) 0.01(3.4)

CCi )13.71(2.8) )0.49()11.2) )0.41()6.3)

EGi )1.67(7.0) )1.05()7.5) )21.3()16.6)

EXi )40.5(2.3) )81.9()4.9) )392()5.7)

R2 0.67 0.76 0.29

DW 1.9 1.9 1.98

JBb 0.80 1.8 3.4

WHETc 28.6 42.3 34.7

aandindicate that an estimate is signi®cantly di€erent from zero at the 5% level and 1% level,

respectively. Studentt-statistics are shown in parentheses. GMM: generalised methods of moments. bJacque±Bera test statistic for normality;pvalue in parentheses.

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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 e€ective 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 ar-gument 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 non-bank investors have a long term view of investment in non-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 in-vestors (banks and banks) may increase their investment in some non-OECD 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

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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 48 48.5 47.1 45.9 43 44.9 46

Bc 19.3 19 19 18.2 17.3 17.5 18.6

Fd 35 35 30.4 39.8 28.5 28 31.6

Other Europe A 1.11 1 1.2 0.008 0.009 0.059 0.007 B 0.02 0.024 0.0221 0.02 0.021 0.025 0.024

F 10.2 9.7 8.2 8 10.8 9.5 11.3

Japan A n.a. n.a. n.a. 5.1 5.5 5.6 5.4

B n.a. n.a. n.a. )0.3 0.03 0.03 0.03

F n.a. n.a. n.a. 1.6 1.4 1.3 1.2

Other Asia A 12 7.9 8.9 10.3 11.3 12.4 12.6

B 15.8 17.8 17.8 19.5 0.2 20 20

F 16 9 10.2 12.4 12 11.3 8.5

Latin America A 4.3 4.3 4.5 4.3 3.3 3.3 3.4

B 20 20.4 21.5 22.5 22.8 23.8 23.7

F 34 34.1 37.3 33 34.4 37.7 3.4

Africa A 0.004 0.002 0.002 0.002 0.002 0.002 0.003 B 0.02 0.02 0.02 0.02 0.025 0.02 0.02

F 1.3 1.7 1.8 1.6 1.6 1.6 0.15

a

Sources:The Survey of Current Business, various issues and Houpt (1988). b

Percentage of the assets of US banks foreign branches. c

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Table 3

Comparison between the assets of US banks foreign branches and US banks' foreign assets (in billions of dollars)a

1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985

The Assets US banks foreign branches 77.4 118.0 140.5 162.7 193.8 227.9 257.6 312.9 343.5 391.0 388.5 386.1 337.4 392.2 The US banks' foreign assets 18.0 23.9 42.5 54.7 72.6 88.0 130.0 156.57 203.9 292.8 401.3 443.1 443.3 446.7 aSource: Houpt (1988) and The IMF, Balance of Payment Statistics Yearbook, various annual issues.

F.

Moshirian

/

Journal

of

Banking

&

Finance

25

(2001)

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Table 5

The correlation matrix for the US/Germany/UK using data in Eq. (2)

X BA FD BT CD CC EG EX

Augmented Dicky±Fuller statistics for the ¯ow model of Eq. (2)

Vari-ables

^

s ^su ^sT

US UK Germany US UK Germany US UK Germany

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