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INTERNATIONAL BANKING COMPETITON: THEORY AND MODERN TRENDS
УДК 336.71 Oleg Volkov
postgraduate dept. Finances, credit and banking of SEI HPE Moscow State University of Economics, Statistics and Informatics (MESI) Tel.: 8-916-148-72-87, E-mail: olegus-volk@yandex.ru
The article focuses on banking competition from the viewpoint of globalization. New approach to classification and differentiation of competition and competitiveness of banks is being suggested; features, drivers and trends of international banking competition and possible present and perspective determinants of international banks contestability are being revealed and analyzed.
Keywords: bank, competition, contestability, globalization, consolidation, future.
Олег Романович Волков
аспирант кафедры Финансов, кредита и банковского дела ГОУ ВПО Московский государственный университет экономики, статистики и информатики (МЭСИ) Тел.: 8-916-148-72-87, E-mail: olegus-volk@yandex.ru
МЕЖДУНАРОДНАЯ БАНКОВСКАЯ КОНКУРЕНЦИЯ: ТЕОРИЯ И СОВРЕМЕННЫЕ ТЕНДЕНЦИИ
В статье рассматривается банковская конкуренция с точки зрения ее глобализации. Предлагается новый подход к классификации и разграничению конкуренции и конкурентоспособности банков, выявляются и анализируются специфические особенности
международной банковской конкуренции, ее движущие силы и тенденции, и вероятные детерминанты
конкурентоспособности международных банков в настоящем и будущем.
Ключевые слова: банк, конкуренция, конкурентоспособность, глобализация, консолидация, будущее.
1. Introduction
Improving competition is considered to be the way of improving quality and availability of goods and services and reducing their price. In modern economy banking services play an important role. However Russian literature pays little attention to the theory of banking competition - among a few researchers we can mark Y. Korobov -although the subject proves to be quite popular and published. Somehow O. Lavrushin, N. Samsonov and others address the importance of banking competition. Competition is generally understood as a process leading from quantity of competitors to their quality. But the qualitative leap could happen as a result of a developed foreign player entrance. Modern development processes of markets and international relations create new environment for banking competition, which requires new approaches to its theoretical analysis and revealing its specific features and tendencies. We think these new challenges to banking competition are: globalization, concentration and non-price competition.
2. Theory of banking competition - from local to global
A majority of Russian authors consider competition as a result of growing number of banks and, as a consequence, sharpening the fight for customer and improving of services. So, O. Lavrushin marks the non-price aspect of competiton, namely the differentiation of services [1]. Another economist N. Samsonov agrees and points out a tendency of commercial banks' services broadening as a consequence of competition [2]. Y. Korobov defines banking competition as a "dynamical process of banking market entities competing with each other, in the course of which they seek to ensure a strong position at this market" [3].
Western literature consider competition as an important incentive of improving banking businesses, "natural selection" of the most effective and suited to market laws banks: "banks need to concentrate on their competitiveness and customers satisfaction" (A. Fight) [4]. Competition even sometimes considered as force capable of regulate banking without participation of the government («free banking») (K. Dowd) [5].
Actually banking, as any other, competition appears, in theory, when on a particular market or is segment a single customer can buy a banking service from more than single bank. In practice - when incumbents or new entrants exhaust the possibilities of extensive growth. Then banking competition enters the stage of direct confrontation, which takes a price form. But only large banks enjoying economies of scale and substantial durability are likely to survive in this case. The most common results are decreasing profits, number of participants themselves and consolidation. Banks face the growth limit, market - the equilibrium price and further price competition becomes pointless and dangerous. But banks need to make profits and grow, and one is both a consequence and a prerequisite of another. So banks come to non-price competition as a way of expanding their market share and source of growth, and to reducing costs - as a way of profit growth.
Relying on the above, we can suggest a slightly different definition of banking competition. Banking competition - a contest between banking market participants caused by the limitedness ofprofit and growth opportunities on the particular market or its segment and aimed at improving their effectiveness and future sustainabil-ity. This definition reflects both the prerequisite of competition (limitedness of resources) and its consequence ("natural selection" of the most effective banks).
The field of competition - banking services market - experiences substantial changes nowadays. The borders are being erased rapidly - when the world's biggest companies do business globally, "to protect themselves at home banks have to be global organizations" (H. Kopper) [6]. Besides the threat of losing clients, foreign market entry is an alternative of growth and profit. The aggregate of international banking competition prerequisities quite precisely can be called globalization. World financial market is being created allowing investors to allocate their temporally free resources with maximum effectiveness and borrowers - to minimize the cost of funds. "Obviously, financial globalization will promote international, rather than local, competition... In this context banking industry must be ready to face a more volatile landscape in the 21st century, than it got used to in the 20th century" (E. Ludwig) [7].
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Table 1. Foreign banks in international banking centers (at Dec.2007)
Switzerland France Hong Kong Singapore UK
Number of banks*, incl. based in: 108 268 194 153 337
inside the country 41 120 19 5 73
outside the country 53 127 131 126 198
outside the BIS- reporting countries 14 21 44 21 61
* head offices
Figure 1. Local claims of foreign banks as share of foreign claims [12]
Banks in possession of competitive advantages, experience and financial resources, enter new foreign markets and join in the competition of different quality. However banks which never left their domestic market also are getting involved in the process of international banking competition.
To be more specific in defining this conception, we need to address the terms of transnational and multinational bank. First one comes from transnational company (TNC), that is bases on cross-border business of the bank outside the country of its origin. Multinational bank - is a bank with subsidiaries outside the country of its origin which finance their assets independently in the host country, which makes him alike a multinational company (MNC) (G. Jones) [8]. In both cases banks involve in international competition, however multinational bank stronger integrates in foreign market as its business model assumes substantial local operations on the liabilities side. So we define international bank as a bank conducting operations at foreign markets by means of physical presence. From the market side international competition appears with foreign-controlled banks (direct investment). So by the residence of banking capital competition can be classified as follows:
1. domestic banking competition -competition of banks controlled by national capital inside the country of its origin;
2. international banking competition - competition of banks controlled by national capital outside the country of its origin.
The first wave of international banking was followed and even provoked by the flourish of colonialism in 19th century; banks of Britain, the colonial superpower prevailed in this wave. It hasn't led to fierce international banking competition: foreign banks' subsidiaries didn't meet strong competitors in colonies. Decades of war and depression following 1914 ended the first wave of banking competition, and forces which gave it power decreased. The second wave led by mac-roeconomic (post-war boom of international trade and investment), regulation (banking restrictions on national markets, e.g. Regulation Q in the US) and micro-economic factors (technology breakthrough, development of banking) factors began in the 1960s [9]. After four decades from the beginning of the second wave almost all the world's biggest banks are
international. They not only dominate nationwide but also control a substantial share of banking business in many countries [10]. This can be confirmed by the data in Table 1 - most of the banks operating in international banking centers are non-residents.
Interconnection of banking systems is growing. Foreign banks enter national market usually following their clients and seeking for growth and profits, leverage of strengths and global risk diversification. They gradually broaden the scope of clients (from TNCs and MNCs to private ones) and services (from account management and loans to investment services and deposits). So grows the integration of foreign banks into domestic banking systems. The international banking model changes accordingly - there is a trend towards local financing (multinational model) rather than raising funds from parent bank (cross-border model) (Figurel).
Multinational model of funding proves to be more stable and less sensitive to the international market and corresponds to maximum integration of foreign bank into domestic market.
The other trends in globalization of
banking are as follows:
1. financial innovation - new products and services appear on the market as from foreign practices, so from new customer needs;
2. internationalization of banks property - almost all the banks are stock companies and taking into account the development of stock exchanges they become multinational from the perspective of property; so their national belonging can change;
3. high share of non-resident banks in domestic banking systems (Figure 2);
4. universalization of banking, creating the banking groups - broadening the scope of services is considered a way of improving competitiveness.
Globalization is a new challenge to banks. Involving the country into international economic relations leads to foreign competitors entering domestic market and national clients entering international markets. This means that banks have to enter foreign markets and face a competition of a new quality, which is not familiar to them in cultural, technological and tactical aspects. International competition requirements to banks' capital, experience, business processes and risk-
management systems are much more strict.
Thereupon arises a question of bank competitiveness - in the matter of globalization we can mark out its three levels. The first one - national, that is an ability to compete with foreign banks when servicing domestic (inside the country) operations of resident and non-resident clients. The second one - foreign, that is an ability to compete with foreign banks when servicing international operations of resident clients. If domestic banks aren't able to compete on the scope of domestic companies operations, they'll loose a market share. And, finally, the third level - overseas (or advanced-foreign), that is an ability to compete with foreign banks when servicing international operations of both resident and non-resident clients. Third level is the highest one and means that domestic banks can compete with foreign bank on their territory (foreign market) when servicing their clients (non-residents). Second and third levels of bank competitiveness make up its international competitiveness.
International competition opens new prospects for banks and establishes new standarts on domestic market if advanced foreign competitors enter it. However national competitiveness does not automatically lead to international competitiveness. What are the determinants of international bank competitiveness? We think that one of the most important is capital.
3. Consolidation and international competitiveness
Objectivity of consolidation processes in banking is caused as by the nature of competition itself, so by high requirements towards capital, technology, management, efficiency etc. At early 1990s banking systems of many developing countries were deeply fragmentized in terms of number and size of banks, their property, profitability, competitiveness, technological and other features. In theese circumstances bank mergers were supposed to be a potentially important base for improving the structure and effectiveness of banking sector. It was expected that they lead to decreasing costs (from economy of scale, better organization, lower fund cost, better risk diversification), and to increasing profits (from economy of scale again, possibility of big deals etc.). In many countries experienced crisis mergers and acquisitions (M&A) were considered a strategy of survival for weak banks; in others government wanted domestic banks to be big enough to compete with foreign players.
Figure 2. Foreign banks' share of bank lending [13]
Consolidation trend is being observed for a long time, M&A in banking has been active till the 3rd quarter of 2007, but slowed down at the end of 2007, just before the crisis hit in 2008 - annual average number of deals dropped from 130 in 2006 to 100 in 2008, regardless the wave of deals for saving crisis-hit banks [14]. Among them were multi-billion deals of buying the biggest American and European banks: HBOS in the UK (bought by Lloyds TSB), Countrywide Financial and Merrill Lynch (bought by Bank of America) and Wachovia (bought by Wells Fargo) in the USA, and Belgian Fortis Bank (bought by French BNP Paribas). British and American deals had a domestic nature, European had a cross-border nature and, as the size of these banks made them pretty unlikely to be acquired, the government assisted buyers from «too big to fail» prospective (otherwise the government would have to save banks on its own). If the local crisis hits the market the value of banks probably drops, which makes their acquisition by international player quite likely and strategically beneficial.
In spite of consolidation is slowing down nowadays, partially because of the lack of potential buyers stability, partially because of illiquidity of the stock markets, the trend will remain, what will affect competitiveness of banks and international competition.
Consolidation which can be measured in static as bank's assets, and in dynamic as M&A deals, promotes the enhancement of international bank competitiveness by several ways:
1. increasing assets and liabilities, number of clients - in other words the size of business, which directly affects growth and profit opportunities;
2. synergy effect from know-how, technologies and best practices of acquired
Экономика, Статистика и Информатика
bank - by acquiring a bank the investor can improve its competitiveness substantially, using all its achievements in the new bank, or even use "back reinforcement" -that is to introduce all the best achievements of acquired bank into its businesses on the other markets (especially when buying special banks);
3. instant entry on the acquired bank' home market and gain of its share - allows to avoid establishing and licensing new bank, to receive a locally familiar brand and its clients, to introduce and promote a foreign brand (co- and rebranding), and to avoid problems arising from cultural, political, economical and social differences;
4. economy of scale - bank of particular size can reduce average costs; researches found that effect is insignificant for relatively small and very large banks, and most tangible for medium and large banks [15];
5. capitalization growth - originates from opportunities of profits and from substantial investment in acquired bank;
6. possibility of large investment in IT, advertizing, upgrading business processes, developing new products and services - only large banks can afford necessary level of spending on IT and innovation, and repay them faster owing to the size of business (for instance, in 2004 Citigroup, Bank of America and Wells Fargo spent on IT about 6, 4 and 3 billions US dollars accordingly [16]).
4. Future of international banking competition - from new services to virtual banks
As we said already - price competition is mostly a feature of developing markets, consequently perspective bank competitiveness will be affected not just by low costs, but loyalty and satisfaction of customers.
Revolution in services happens rare-
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ly, and innovations anyway spread through the market quickly, that's why the bank's goal is to offer the most easy and convenient solution to all the client's tasks, that is not to sell a standard kit of operations or services, but products flexible and adaptable to clients needs. And also - to improve not only services and products, but the ways of distributing them.
Bank's image and brand will play very important role as a way of competitive differentiation. Global brand at local market will be a competitive advantage, in case of acquiring a bank - improve its image. The tactics of rebranding and cobrand-ing will serve as conductors of international business of banks at local markets.
Special or universal banking - is a factor affecting banking competition twofold. Special banking on one hand relaxes competition as a special bank competes in particular, "own" segment of the market; on the other hand, specialist should possess a unique know-how in its business, which could lead to losing this segment by universal banks. Universal banking on one hand makes banks cover a variety of services, which intensifies competition in general; on the other hand universal bank may scatter its resources in an attempt to cover the whole market, without achieving an efficiency on any single segment. M. Porter shares this point of view: "not mergers and best practices form a strategy, but competitive differentiation" [17].
He thinks that banks must concentrate on their key segments and even miss some opportunities in the sake of stable growth of key segments.
However synergy effect from buying specialists allows to follow the path of universal banking without losing quality - M&As promote introduction of new areas in the international business of bank, who can become either a "financial supermarket" or universal bank on the banking group (parent bank) level and special bank - on the level of affiliated banks.
Distribution networks - is another important weapon of competition. Trend of such networks automation - from traditional offices towards ATMs with enhanced functionality and electronic banking will also remain. Possibly in the future virtual banking will prevail. Virtual bank (direct bank) - is a bank operating exclusively by the Internet and having no distribution network. There is a few of such banks: most of the projects were integrated in parent bank business, acquired or gone. However the experiments showed
that virtual banks are viable and can build up a substantial customer base. As an example of purely virtual bank we can take the Egg Bank, which operates from 1998.
5. Conclusion
How will the international banking look like in the future? In our opinion trends which took place last decade will remain: players build up the capital, actively expand their businesses by the use of M&As and follow multinational model of banking. Financial crisis provoked a wave of M&As, proved multinational banks to be relatively stable at local markets and led to migration of clients. These trends will further intensify the competition on local markets and between international banks - on the global market. Technologies and innovations will remain important and at the same time expensive driver of competitiveness growth. Focusing on customers will help banks to understand the needs of present and prospective clients and create and price products accordingly.
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