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Foreign bank ownership and business regulations

Manthos D. DelisSurrey Business SchoolGeorgios P. KouretasAthens University of Economics and BusinessChris TsoumasUniversity of Piraeus

Centre for Financial Risk Analysis-EM Lyon Business School, Thursday 27 March 2014AgendaGoal and MotivationLiterature reviewDataEmpirical methodologyResultsConclusions2Goal and motivationMotivationEntry 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?GoalTo examine empirically the impact of foreign bank presence on host countries institutions, specifically business regulationsQuestion of increased importance due to its:Importance for long-run growthPermanent natureIssue not addressed so far in the literature

3Literature 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 of4Literature Reviewany 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 countrys 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.5Literature 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.

6DataLarge (unbalanced) panel dataset8 large databases employedAnnual data114 countries (both advanced and emerging)1995-2011 period5 distinct dependent variablesLarge array of control variables

7Data8Dependent variables VariableDefinitionSourceBusiness 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 datasetFreedom 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 datasetRegulations Measures the regulatory environment for a country regarding credit market, labor market and business regulations. Property rights Measures the degree to which a countrys 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). Dependent variables characteristics9Heritages business freedom:Sample period: 1995-2011Range: 10 to 100Frasers variables:Sample period: 1995 and 2000-2011Range: 0 to 10 Higher values indicate more efficient regulations

CorrelationsBusiness freedomFreedom to trade internationallyRegulationsProperty rightsBusiness freedom1.00Freedom to trade internationally0.571.00Regulations0.510.561.00Property rights0.690.600.581.00Business regulations0.630.580.740.73Variable 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 Data (contd)10Explanatory variables (Main model)VariableDefinitionSourceForeign 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 databaseGDP per capita(log) Purchasing Power Parity (PPP) adjusted Gross Domestic Product (GDP) per capita at 2005 constant international $ prices (Chain Series)Penn World Tables 7.1GDP growthGDP growth (%)World Development IndicatorsInflationInflation, GDP deflator (%)Bank credit to bank deposits Bank credit to bank deposits (%)Global Financial Development databaseInward FDI flowsInward direct investment flows, as a share of GDPUnited Nations Conference on Trade and Development (UNCTAD) statisticsOpennessOpenness at 2005 constant prices, as a share of GDPPenn World Tables 7.1Data (contd)11Additional explanatory variables (Enhanced model)VariableDefinitionSourceDemocracyPolity2 measure of democracy Polity IV databaseSound 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 orientationMeasures 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 InstitutionsPluralityDummy 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 dummiesDjankov et al., 2007Explanatory variables characteristicsObs.MeanSt. Dev.Min.Max.(log) Foreign bank presence1,8253.360.91504.605(log) GDP per capita2,1608.7231.3215.6211.822GDP growth2,2760.0420.046-0.180.89Inflation2,2750.141.251-0.32853.995Bank credit to bank deposits 2,18399.32363.9418.612898.048Inward FDI flows2,23600.001-0.0060.007Openness2,1600.8270.5170.0884.33Democracy2,1994.0456.42-1010Sound money1,5327.9431.68909.9Chief executive party orientation2,261-8.40398.223-9993Plurality2,239-77.057267.68-999112Sample 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 detectedEmpirical MethodologyThree estimation techniques Pooled OLS

Busreg: measure of business regulations in country i at time tLagged dependent included to account for possible persistenceFB: foreign bank presence (n takes the values 1 or 2)Xj: array of variables that may affect business regulationsLegal origin and religion dummies includedt: time dummiesTwo models: Main model: Xj includes main macroeconomic variablesEnhanced model: Xj adds institutional and political characteristicsYet, 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.

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Panel GMM (Arellano Bover / Blundel Bond)To account for:Endogeneity issues (i.e., reverse causation from business regulations to foreign bank presence)Countries fixed effectsIdeal method for large N - small T, as in our caseXjs instrumented with their lagged values (i.e., L2; L3)FB instrumented with:Frasers 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

14Empirical MethodologyTreatment effects model (two stage IV model)First stage:

FBxit is a dummy with 1 for foreign bank presence and 0 otherwiseFour distinct dummies employed:FB10: 1 if foreign bank presence >=10%FB20: 1 if foreign bank presence >=20%FB30: 1 if foreign bank presence >=30%FB40: 1 if foreign bank presence >=40%zit is the instrument used in the panel GMM caseSecond 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 groupn takes values 1, 2 and 3Busregit-1 accounts for the possible differences in the trend of the dependent variable between the treated and control groups before the treatmentSystem estimation15Empirical Methodology

16Panel 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 OLSMain model Heritages business freedom 17Enhanced model Heritages business freedom Panel A: Pooled OLSPanel B: GMMLagged dependent 0.860***0.844***0.916***0.922***Foreign bank presencet-20.447**1.682**Foreign bank presencet-10.560***1.414GDP per capita t-10.847***0.883***0.859**0.718**GDP growth t-1-2.629-2.6660.859-0.186Inflation t-10.0060.024-0.041-0.021Bank credit/Deposits t-10.003**0.004**0.012***0.011**Inward FDI flow t-1-359.220-411.763618.835717.980Openness t-10.1060.255-0.873-0.862Democracy t-10.0190.0210.0510.040Size of government t-10.0150.037-0.149-0.131Property rights t-10.1350.161*-0.023-0.026Sound money t-10.0790.097-0.070-0.037Freedom to trade intern. t-10.021-0.007-0.271-0.270Regulations t-10.438**0.466**0.571*0.528*Government party orientation t-10.0000.000-0.002-0.003Plurality t-10.0000.000-0.0000.000DiagnosticsObs.1,4401,4181,4901,464No. of countries107107111111Adj-Rsq.0.890.88No of GMM instruments5555AR2(p-value)-0.26-0.63(0.79)(0.53)Legal origin and religion dummies not reported for pooled OLS18Treatment effects model Heritages business freedom Panel A: 1 year aheadPanel B: 2 years aheadPanel C: 3 years aheadDependent 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-8.04-22.71-29.89FB dummy 20 at t12.5516.29*17.48*FB dummy 30 at t6.598.61*9.20**FB dummy 40 at t4.536.056.38*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***0.010.01***0.01**0.01**Inward FDI flow 667.13*483.33450.96461.66971.60*724.63699.07710.321205.37*910.94*897.67*910.98*Openness 0.530.360.450.440.540.300.410.360.640.380.500.41First stage probitForeign ownership-Investment restrictions-0.04*0.04**0.07***0.07***-0.030.05**0.08***0.09***-0.020.05***0.09***0.10***Constant1.43***0.24*-0.29**-0.70***1.36***0.15-0.42***-0.82***1.30***0.09-0.52***-0.95***Obs.1,3301,3301,3301,3301,2281,2281,2281,2281,1271,1271,1271,127Pseudo-Rsq.0.000.000.010.010.000.010.010.010.000.010.010.02Legal origin and religion dummies not reported19Main model Frasers variablesDependent variable is Freedom to trade internationallyPanel A: Pooled OLSPanel B: GMMForeign bank presencet-2 0.0170.376**(1.544)(2.076)Foreign bank presence t-10.026**0.448**(2.168)(2.068)DiagnosticsObs.1,0609671,094997No. of countries109107114111Adj-Rsq.0.920.92No of GMM instruments3734AR2(p-value)-0.58(0.56)-0.72(0.47)Dependent variable is RegulationsPanel A: Pooled OLSPanel B: GMMForeign bank presencet-2 0.020-0.074(1.306)(-0.969)Foreign bank presence t-10.021-0.056(1.278)(-0.597)DiagnosticsObs.1,0899951,1231,025No. of countries109107114111Adj-Rsq.0.890.88No of GMM instruments4541AR2(p-value)0.53(0.60)0.62(0.54)20Main model Frasers variables (contd)Dependent variable is Property rights Panel A: Pooled OLSPanel B: GMMForeign bank presencet-2 0.0100.144(0.755)(0.943)Foreign bank presence t-10.0100.177(0.658)(1.140)DiagnosticsObs.1,0639691,097999No. of countries109108114112Adj-Rsq.0.950.95No of GMM instruments3734AR2(p-value)1.16(0.24)1.24(0.22)21Treatment effects model Frasers Freedom to trade internationallyPanel A: 1 year aheadPanel B: 2 years aheadPanel C: 3 years aheadFB 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 probitForeign ownership-Investment restrictions-0.08**0.08**0.10***0.14***-0.060.10***0.13***0.17***-0.040.11***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.828828828828727727727727626626626626Pseudo-Rsq.0.010.010.010.020.000.010.020.020.000.010.020.03Panel A: Pooled OLSPanel B: GMMForeign bank presencet-20.034*0.254(1.870)(1.501)Foreign bank presencet-10.034*0.729**(1.736)(2.002)DiagnosticsObs.1,0049111,038941No. of countries109107114111Adj-Rsq.0.840.83No of GMM instruments3936AR2(p-value)-1.04-0.31(0.29)(0.76)22Main model Frasers Business regulationsTreatment effects model Frasers Business regulationsPanel A: 1 year aheadPanel B: 2 years aheadPanel C: 3 years aheadFB dummy 10 at t-4.32**-5.35*-7.87(-2.18)(-1.68)(-1.22)FB dummy 20 at t6.174.543.73*(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 probitForeign ownership-Investment restrictions-0.11**0.050.07**0.11***-0.09*0.07*0.09**0.14***-0.070.08*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.783783783783682682682682580580580580Pseudo-Rsq.0.010.000.010.010.010.000.010.020.000.010.010.02ConclusionsForeign bank presence does affect business regulations, measured byBusiness 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 internationallyEvidence for impact 2 and 3 years aheadImpact for foreign bank presence larger than 30%Larger than 20% for freedom to trade internationally

23Thank you for your attention!

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