DOES FOREIGN BANK PENETRATION

IN DEVELOPING COUNTRIES AFFECT

THE WELFARE LEVEL?

Emiel Jerphanion
s338668

Tilburg University
Tilburg School of Economics and Management
Bachelor Thesis

Supervisor
N. Dwarkasing
Table of contents

Table of contents 2

Chapter 1: Introduction 3

Chapter 2: Literature review 5

2.1 Bank entry in General 5

2.2 Regulation 6

2.3 Drivers foreign bank entrance 8

2.4 Economic growth as result of foreign bank penetration 10

2.5 Developing economies, economic growth and poverty effects 11

2.6The case of the Philippines 14

Chapter 3: Methodology and data 18

Chapter 4: Descriptive statistics 22

Chapter 5: Results 27

Chapter 6: Conclusion and Discussion 29

List of references 31

2
Chapter 1: Introduction

In developing countries the foreign banks have higher profits than the domestic bank

(Claessens et al. 2001). Micco, Panizza, and Yanez confirmed this and stated that foreign

banks are both more profitable and more cost efficient than domestic banks (2004). The entry

of foreign banks in the banking sector of developing countries have proved to a possibility for

restructuring the banking sector in a more efficient and competitive sector(Clarke et al. 2003).

The Banking market reacts to the entry of foreign banks in two steps. In the short run the

profits and the margins of the domestic banks are reduced, with the possibility of the

bankruptcy. In the long run the national banking market functioning is improved, this has

positive welfare indications for the bank consumers. (Claessens et al. 2001). The effect of a

growing economy due to a better functioning banking sector raises total lending, cost

efficiency and welfare, but this effect is not warranted (Detragiache et al. 2008).

The entry of foreign banks also affects the access to credit. The expectation was that the entry

of foreign banks would harm the access to credit for small- and medium enterprises because

foreign banks are considered to be mainly large international firms and therefore have a strict

policy concerning credit lending. For small- and medium enterprises in developing countries

it would be harder to get credit for they are unable to satisfy the strict policy of these firms.

This has proven to be wrong, on contrary the foreign banks appear to be interested in local

lending to opportunities in developing the economy, even more as they do so in developed

countries. The remark hereby is that although small- and medium enterprise benefit, the

positive effect on larger companies is stronger (Clarke et al. 2003). All studies on the subject

of foreign banks show that their entry and their presence influence the market and thereby the

economy. Although in the discussion over the effects on the economy it is clear that it leads to

3
growth of the economy, for instance close to all studies show a raise in GDP in the host

country. But how is the increase of the GDP distributed in developing countries? Because in

those countries the welfare level desires strongly for positive influences. So the main

question is: does foreign bank penetration in developing countries affect the welfare level in

those countries?

4
Chapter 2: Literature review

2.1 Bank entry in General

Bresnahan and Reiss (1987) show entry on a local level is mainly determined by the expected

profitability of the market, the concentration in the market, the entry barriers and the

efficiency of the existing companies. Whereas the last reason is assumed to become

increasingly more important in larger markets. Entrance in the specific sector of banking is

likely to be complex due to the significant role of trust of consumers, strongly influenced by

familiarity with the provider of the financial products. Furthermore there are strict regulations

in this market and a fairly high starting capital is needed. A thoughtful policy is demanded

before bank entry in a region or country. In the most western countries the domestic banking

sector is dominated for decades by a few large banks, because people do not easily change

between banks. Existing banks has a proven level of reliability and is therefore considered

safer than moving to an entrant. Schmalensee (1989) confirms this view on the banking sector

by showing that in industries with high scale economies, high required starting capital and

highly differentiated products the entrance of new firms is lower compared to other industries.

DeYoung (2002) showed in his study on new banks in England during the 1980s that both the

choice of the regional location as well the post-entry behavior of the entrants is essential to

their survival, also economic growth and competiveness of the regional banking sector has

some influence on the possible bank failure. The external market conditions that influence the

failure of new entrants have a very marginal effect on established banks. This may be

explained by the relevance of trust in and familiarity with the bank, once this is gained a bank

becomes close to immune to external market conditions. The behavior of the new entrants,

both aggressiveness as well as diversification, may lead to a distinction from the established

banking sector. For entrants it‟s essential to distinguish themselves from the existing banks,

5
hereby 2 different types of bank entrants can be distinguished. On the one hand there is the

bank that is known by the potential consumers, because they are known for their operating

performances in a familiar market, for instance an other region within the same country. On

the other hand there is the entrant which is completely unknown by the potential consumers.

When an entrant is known it can be both an advantage as a disadvantage, this relies heavenly

on how they are known. When this is positive it is easier to gain trust, but when this is not

good it is even harder to gain trust because they have to overcome the negative image they

have.

Fraser and Rose (1972) researched the effect of local new bank entry on the banking

performances. They stated that the appearance of bank entrants resulted in significant changes

in the banking performance of the established banks. The banking services were reformed and

revised, which led to higher loan-asset ratios and a greater emphasize on providing loans, both

for businesses as consumers. Furthermore the established banks had to join in the, at that time

relatively new, market of time deposits. When bank entry in local markets result in a change

of the banking performances one might argue that at an international level this effect is even

stronger because Berger and Udell (1996) proof that small bank lend relatively more to small

businesses compared to large banks, so an international entry will shake a bigger market.

2.2 Regulation

The theory on the regulations concerning bank entry shows two major views. The one view is

that strong regulations had a positive effect on the stability of the banking sector; the other

view is the more liberal approach whereas little regulation improves the effectiveness of the

banking market through a fiercer competition. Focarelli and Pozzolo (2000) show a

preference towards countries with fewer banking regulation restrictions when it comes to

6
investment by foreign banks. Goldberg and Grosse (1994) find in their study on the presence

of foreign banks linked to the different states in the United States of America that foreign

banks have a greater presence in states with less strict regulations on foreign activity. This

research is particularly interesting because it covers differences between states in the same

country, but with a high regulatory autonomy. In case a bank want to open in the USA the

choice for the state has arguably something to say about the ideal settling situation of foreign

banks. The geographic market factor is obviously important, but a reputational situation is

also a factor. Hultman and McGee (1989) argue that tax laws may also affect foreign banks‟

decisions about where to locate and what type of office to establish. A desirable tax climate

has a positive effect on foreign bank entry.

In a analysis of the competition and effectiveness of the Hungarian banking sector Vittas and

Neal(1992) show the impact of foreign banks, nevertheless they state that the impact of these

foreign banks could have been more substantial if they were allowed to open branches or fully

owned subsidiaries. Due to restrictions the only way for foreign banks to involve in the

Hungarian banking sector was through joint ventures. Even before the introduction of the

two-tier banking structure there were 2 joint venture banks, however the introduction of the

two tier banking structure by law in 1987 led to an increase of foreign banks to 22 in 1991,

mostly from neighboring countries. However due to the regulations concerning foreign

banking institutions it remained impossible for foreign banks to fully own a banking

institution in Hungary. Regulation and restrictions in domestic markets affect the entry of

foreign banks, but on the other hand a certain level of judicial development is desired as

described in the following sub-chapter.

7
2.3 Drivers foreign bank entrance

The literature on the drivers of foreign bank penetration shows four main reasons. Banks have

the desire to follow their home customers by being physically present to the areas whereas

due to the internalization operational activities are exploited. Focarelli and Pozzolo(2001) find

a highly significant effect between the bilateral trade on the probability that banks will open a

foreign subsidiary.

Furthermore a bank is driven by the opportunities towards growth and profit. Goldberg and

Johnson(1990) linked foreign bank penetration in the US to the concentration of banks and

measures of real GNP and GNP per capita. Areas with a low concentration of banks and high

GDP measures had a substantially higher level of foreign bank penetration. Banks, just like

other commercial enterprises, seek for business opportunities. Focarelli and Pozzolo(2001)

showed that the local market opportunities are the main determinant whether and where to

expand. Countries with a banking sector suffering with high costs, low efficiency and low

returns have a positive correlation with foreign bank entrance. This somewhat surprisingly

result can be explained by the fact that the kind of banks that expand their businesses over the

domestic borders are mainly large multinational banks, due to scale economies and experience

this banks are often more effective. Because the operational effectiveness is one of main

distinctive qualities of the banks willing to expand their foreign subsidiaries prefer to settle in

areas where this competitive advantage can be optimally exploited. Subsequently is stated that

financial depth and inflation level of the country assign a decisive role.

Bresnahan and Reiss (1987, 1990 and 1991) have designed and tested a model to analyze the

bank entry in relation to the expected provability. The provability in the analysis methodology

is mainly determined by the number of firms in the market in relation to the size of the

8
market. The more favorable the demand conditions the higher number of potential

competitors may be for the bank to enter.

The third focus reason in the literature is the presence of mechanisms that might help mitigate

the information costs. Tsai et al(2009) links higher foreign bank participation to the existence

and quality of the credit reporting agency. The presence of a well functioning credit reporting

agency lowers the risk that the lack of solid information brings in business activities. High

risk or uncertainty about the risks holds the penetration of foreign banks back as the

commercial considerations turn negative. A Positive effect is found in the proximity between

the host country and the home country on the foreign bank penetration, as well as a common

language has a positive effect on foreign bank penetration (Buch, 2003; Buch and De Long,

2004). Similarities in culture and language makes the adventure of expanding abroad smaller

as well as the foreign banks are more easily accepted by the consumers of the host country.

These are mechanisms in order to get information effectively; in case of default as a

consequence of information asymmetry the judicial determinants of a country have proven to

affect the foreign bank penetration. Galindo et al.(2003) find that in country with less

corruption and greater adherence of the law have higher levels of foreign bank participation.

The final driver of foreign banks is mainly policy based, the caliber of the entry barriers.

Foreign banks are only able to enter a domestic market in case there is market liberalization.

Studies demonstrated that foreign bank penetration is higher in domestic markets with few

regulatory restricts (Goldberg and Grosse, 1994; Focarelli and Pozzolo, 2000; Buch

and De Long, 2004; Galindo et al, 2003).

9
2.4 Economic growth as result of foreign bank penetration

A study over the openness of an economy and the income levels by Frankel and Romer

(1999) shows a robust positive relationship between trade and the income levels, especially

the long term income levels. As stated before that a driver of foreign banks is to follow their

customers foreign banks and trade seem to have a positive relationship. The Economic

Research Service of the Department of agriculture of the United States state a proven

relationship between geographic regional liberalization and local economic growth in the

short run. Though the liberalization bank entry is made possible and though financial growth

economic growth is stimulated. At an international level is the influence of foreign banks to

the economic growth directly as well indirectly. Demirgüç-Kunt, Levine and Min(1998) state

that the additional capital, the corporate control and the risk management facilitate a direct

effect on economic growth. By contesting and sharpening the market the entrance of foreign

banks lead to domestic market efficiency. The improvement of the performance of the

domestic market stimulates the economic growth. Furthermore is proven that foreign banks do

not jeopardize the stability of the market. The case of Korea is described and empirically

examined and the results support the hypothesis that the entry of foreign banks tends to boost

the financial stability and therefore have a positive effect on the economic performance of

Korea. Important to the effect of foreign bank penetration to economic growth is the reaction

of the domestic banks. In the case of Korea Demirgüç-Kunt, Levine and Min show that the

domestic banks react aggressively and competitively and therefore the domestic banking

sector is reformed.

McFadden (1994) finds that domestic banks in Australia also reacted aggressively towards

foreign bank entry. They improved their operations, invested in upcoming technologies and

reduced their costs. This reaction made that the foreign banks had lower profit margins and

10
market shares than expected. Unite and Sullivan(2003) conclude that in the case of the

Philippines foreign competition in the banking sector compels domestic banks to be more

efficient , to focus operations and to be less dependent on operational activities based on

relationship. In paragraph 2.6 the Phillipine case will be examined in more detail.

In a study over Eastern Europe Giannetti and Ongena(2009) state that foreign banks affect the

total volume of credit but also affect the allocation across firms. In particular young local

firms benefit from the presence of foreign banks. Other empirical studies focus on Eastern

Europe and Latin America since their banking markets are liberated in the last decades.

Practically all papers on this subject find a significant growth in number and market share of

foreign banks. Yeyati and Micco(2003) find that in Latin America the penetration of foreign

banks reduce the competition. This may be explained by the fact that due to the difference in

effectiveness between foreign banks and domestic banks the competition becomes fiercer and

so the market requires a higher level of effectiveness. Some banks might go bankrupt as a

result of this effect; therefore the absolute competition becomes smaller. Domanski(2005)

shows that in these regions the benefits can be more exploited, this leads to changes for the

governance.

2.5 Developing countries, economic growth and poverty effects

In this crisis time the definitions of development countries and developing countries are

revised as the definitions were largely founded on ancient world views. The countries in

Africa were developing countries and Western Europe and North America was the region of

developed countries. The relationship between those areas was unilateral because the

developed and rich countries had to help the poor and underdeveloped countries and those

countries couldn‟t offer much in return because they were less developed. With the recent

11
crisis the countries in the rich west notice that their economies are not infallible and the

growth is not everlasting, meanwhile several countries in Africa grow rapidly. According to

the CIA world fact book there is not a single country in Western Europe that is above the

world average of the real GDP growth rate, while countries that evoke a vivid image a

prototype of developing countries as Eritrea, Mozambique, Ghana and Papua New Guinea

dominate the top of this list. This recent development makes it increasingly more difficult to

distinguish a developing country. The World Bank classifies countries into 4 income

categories: low-income-economy, lower-middle-income economy, higher-middle-income

economy and high-income economy. The used definition of developing country in this thesis

will be a country with a low-income economy or a country with a lower-middle-income

economy, in total this category contains 91 countries.

Detragiache, Gupta, and Tressel(2006) show that in low income countries the financial sector

performance is more strongly influenced by some factors than in high income countries.

Fundamental factors as corruption and inflation have a strong negative effect on the financial

performance. Reliability has a strong positive effect; the financial reliability is in a large

extent determined by the degree of contract enforcement and the degree of accessible proper

information concerning the credibility of borrowers. Overall one might conclude that the

financial sector in low income countries tends to be unstable though the strong effect of the

influences described above.

Furthermore they state that foreign bank penetration in lower income countries does not lead

necessarily to a more efficient market. By reckoning the size of the economy in the regression

the effect of scale economies are excluded, because banks seem to be more efficient in large

economies. Also the effect of the mortality of new entrants in the financial market proofs to

be of little effect to the efficiency of the bank. While inflation is stated as an important factor

12
to the bank efficiency. The influenceable economy of developing countries make the effect of

foreign bank penetration unpredictable. While a greater presence of state-owned banks is

correlated to lower overhead costs and more bank deposits. It seems that the more compact an

economy is the more it desires for known players and factors within the market, but the

potential to grow is much smaller. Rodrik (2001) proofs that host countries must face the

challenge to make openness work in the actual global economy. The free market gains need

complementary policies and institutions next to the free market mechanism itself to be of full

effect. He states that a free market is not a goal but a way to growth. Later on in the book he

warns for the effect of the desired openness of the economy on the income distribution,

openness tends to widen the gap in income distribution. Lensink and Hermes(2004) show that

the short term effect of foreign bank penetration in countries with lower economic

development is generally associated with both higher costs as well with higher profits in the

domestic banking sector. The effect of foreign bank penetration in those countries is far more

clear and evident than in higher economic developed countries.

Levine(1997) proofs the importance of financial growth on economic growth. So a more

efficient and deeper financial sector, which can be achieved by developments of the banking

sector, result in a economic growth. Levine and Zervos (1998) find that both the size of the

banking sector as well as level of banking sector development are positively correlated to

economic growth. Economic growth is seemingly a essential condition in reducing poverty, to

proof whether a economic growth implies a growth in welfare Simon(1973) shows three

conditions under which economic growth does not imply a growth in welfare. Welfare

associated with income is relative; the income distribution needs to change for a growth in

welfare. Furthermore might the growth of income lead to life changing decisions, which

might not be in all cases supporting the growth of personal welfare. Finally possible

13
unmeasured disutilities might come with economic growth and have a negative impact on the

welfare level. Mishan(1967) referred to the disutilities as external diseconomies in his critics

on economic growth.

In a research on the relation between economic growth and poverty the claim that economic

growth always leads to a reduction of poverty is investigated by the examination of evidence

of developing countries in the 1980s by Ravellion (1995). He states that economic growth has

a proven positive effect on the average incomes and thereby has some effect on reducing

poverty, nevertheless his regressions show that there is a sizeable unexplained variation

between countries in the decrease of the poverty in relation to their economic growth. This

can be explained by the differences of initial conditions as well by the non-economical

segment of poverty; access to schools and healthcare. He states that the average living

standards will rise but the relative position of the poor will not change, neither increase nor

decrease. He does find that the absolute consumption poverty responds quite elastically to

change in average living standards, this effect is negative. In his successive study (1997) he

finds that the initial distribution has a strong effect on the how much the poor benefit from a

rise in average livings standards. The higher initial income inequality the lower the effect of

economic growth on absolute poverty, with high initial inequality poverty might increase as a

result of economic growth.

2.6 The case of the Philippines

The Philippines have changed their economic policy towards the liberalization and

internationalizing of its domestic financial markets only a few decades ago. Because the clear

and single moment of opening up to foreign financial players The Philippine case is an

interesting example to look at with regard to foreign bank penetration. Also the fact that the

14
government plays a very marginal role in the financial sector, in contrast to several other

developing countries, both in bank ownership as restrictions concerning capital accounts or

other operational limitations, make it interesting to look at the Philippine case for the effects

of the foreign bank entry is not hold back by any restriction. Unite and Sullivan (2003) have

investigated the process and the effects of foreign bank entry which took off after the new

policy of removal of barriers to foreign financial institutions became official by law in May

1994. The new regulations consisted 2 main new changes to the financial market entry,

foreign banks were allowed to enter the Philippine market and new incentives for foreign

institutions to buy and own common stock of the domestic banks were created. The existing

domestic banks could be for up to 60% bought by foreign banks. The argument given for the

new policy was to create a more competitive domestic financial sector.

The number of foreign banks increased from 4 to 14 in the year after the new laws in 1994.

The new foreign presence in the Philippine financial market give clear changes to the interest

rate spreads risks and performance of operating activities. Foreign bank entry leaded to a

general incline of interest rate spreads and profits, this might be explained by the fiercer

competition, but this effect was only significant for the banks that were affiliated to domestic

family business groups and proofed to be stronger as the bank was bigger. The entry of

foreign banks also leaded to an increase in banks risks and a decline of operating expenses.

This effect suggest a financial market efficiency improvement, in order to for the banks to

distinguish themselves in the renewed market efficiency was needed. But the will to

distinguish also brings a increasingly level of risk taken by the banks.

The effect of foreign ownership in existing domestic financial institutions has a less strong

effect to the market than foreign banks, but at some areas an opposed affect. The increase of

15
foreign ownership in domestic financial enterprises leaded to an increase of operating

expenses. This might be explained by a larger focus on service, specialization and expertise

which a foreign bank brings into the domestic enterprise. Also economic factors were

investigated; a rise in the GDP level proofed to be of no effect to the interest rate spreads but

to have a positive effect to the profits. This is easily explained by the fact that a economic

growth leads to more economic transactions, so if the interest rate spreads keep the same the

total profits will rise due to the increase in transactions.

Gerson (1998) states that the lack of improving the poverty standards in the Philippines in the

period before 1994, especially compared to neighboring Asian countries, is due to the poor

economic growth. The growth was mainly retained by the elite, therefore seen by him as

responsible for the high incidence and persistence of poverty in the Philippines. He states that

the developments in 1994 have spurred economic growth and therefore should be stimulating

in the alleviation of poverty. The GINI index and the GDP level of the Philippines do not

react in a notable way until the year 2000, whereas the GINI index begin to take lower levels

and the GDP accelerates from 2001 on at a formerly unknown slope. But Unite and Sullivan

as Gerson state that the obstinacy of the elite had slowed down the economic effects of 1994

though both permissible as impermissible ways. Up till recently foreign banks were allowed

to enter physically several regions the Philippines that were formerly forbidden for foreign

bank subsidiaries. In 2014 the ban for foreign banks to enter in 8 major cities will be lifted,

still with the argument of the desired improved competitive financial sector. So the

liberalization of the Philippine market will at least endure till then, covering a period of 20

years. The expectation of Unite and Sullivan in 2003 was that banks would become more

independent and lose much of their political influence, which would have a good effect on the

lending practices and the appreciation of human capital. This would lead to a growth in

16
economy and an incline in poverty. Looking at the 20 years of reforming the financial market

show a positive relation between the growth of the liberalization of the domestic financial

sector and the economical growth. Furthermore the poverty level has inclined in those 20

years, but this has gone very gradually. But the part that foreign banks in these effects had is

unclear for the Philippines and will be hopefully better to identify with the results of

regressions below.

17
Chapter 3: Methodology and data

The extent of the effect of the foreign banks presence in developing countries on the level of

welfare is investigated by the following model, with t measured in years.

Log value of the GINI index α + β1(foreign bank assets/total bank assets at t-2) +

β2(unemployment rate at t)+ β3(inflation at t as from the year 2000) + β4(life expectancy at

birth at t)+ β5(access to education at t).

The log value of GINI is the dependent variable measuring the level of welfare in a country in

a social-economic way. The GINI is an index between 0 and 1 with 0 as perfect equality and 1

as a perfect unequal welfare distribution. A change from a relative high GINI to a lower GINI

value is considered to be a welfare improvement. Because the GINI is a persistent variable the

relative differences are assumed to be small. The differences in social economic conditions

are only slowly processed into the GINI coefficient. To be able to extract the effect of the

independent variables to the GINI as independent variable a correction towards the

persistence of the GINI is desired. For this research question that correction is too

complicated because this research question is only a first indication towards to effect of

foreign bank penetration on the level of welfare, in this case measured by the GINI.

The foreign bank penetration, measured in bank assets in foreign hands divided by the total

bank assets, has proven to have a positive effect on economic growth (Demirgüç, Levine and

Min 1998). This effect is stimulated by the effects on the financial market due to foreign bank

penetration: increased financial stability at the long run (Demirgüç, Levine and Min 1998),

increased efficiency (Clarke et al. 2003) and the effects on credit (Clarke, Cull, Peria 2001).

The economic growth created by foreign bank penetration is supposed to lead to an increased

welfare level (Ravellion 1995, 1997). Because this effect would be initiated by the economic

18
growth and the economic growth is mainly a result of financial developments, the foreign

bank penetration is taken at t-2 to include the time to see this effect.

+
H1: foreign bank assets/total bank assets at t-2 Log value of the GINI index at t

The unemployment rate is a variable to measure a important social-economic determinant of

the welfare level. Different reactions of income equalities as a result of a change in the

unemployment rate is shown by Aaberge et al. (2000), furthermore they state the relative

small effect of the unemployment rate on the GINI index. The expectation is that a lower

unemployment rate is good for the disposable income level in a country which suggests an

improved welfare level, although this effect is assumed to be relatively small.

-
H2: Unemployment rate at t Log value of the GINI index at t

Inflation is assumed to be of a negative influence to the domestic expenditures as well in

relation with other countries. The exchange rate rises because of inflation and as a result the

interest rate rises. A higher interest rate results in a higher national debt and therefore the

governmental stimulation of welfare is harder because the government is „poorer‟.

-
H3: Inflation rate at t Log value of the GINI index at t

Life expectancy shows the healthcare conditions in a country in a direct influence able

variable because every year the life expectancy is adjusted to the life expectancy at birth for a

newly born child. Because the GINI index consists out both economical as non-economical

variables an improved health care level is expected to be desirable when chasing a GINI

growth. Furthermore there is a small positive effect of life expectancy at birth to economic

growth (Acemoglu, Johnson 2007), but they also state that the life expectancy at birth brings

19
population growth and the growth in population is relatively larger than the economic growth.

So in terms of welfare this effect is somewhat unclear.

-/+
H4: Life expectancy at birth at t Log value of the GINI index at t

Access to education is proofed to be a large positive effect (Psacharopoulos 1977), he states

that almost a quarter of the GINI index is created by the level of access to education. An

educated population brings more people in to positions of well paying jobs and may seduce

foreign investors, which both bring an increase in welfare level.

+
H5: Access to education at t Log value of the GINI index at t

To acquire the data information is extracted of the CIA world fact book, the World Bank

database and Bankscope. The data covers a period of 1995 until 2005 with regard to the

foreign bank information and the years 2004 and 2007 with the other variables. To exclude

potential harming effects of the worldwide financial crises in 2008 this was the period

considered both actual as reliable. Below is a list of variables.

Table 1. List of variables

# Variable
1 Foreign banks
2 Unemployment rate
3 Inflation
4 Life expectancy at birth
5 Access to education
Use
The financial assets in hands of foreign bank divided
by the total assets
A percentage of the working population which are
unemployed
Inflation level with the year 2000 as basic level
Measured in years
Percentage of the population that was or is enrolled
in primary education

6 Time Measured in years

20
Foreign banks are measured by the amount of assets they hold instead of the number of

foreign banks in relation to the total amount of banks in order to include the relative impact of

the foreign banks in the domestic economy. The employment rate, inflation and the life

expectancy at birth are variables to measure the social welfare concerning work, healthcare

and buying power. Life expectancy at birth is taken in order to measure the immediate effect

in life improvements. The life expectancy and the access to education need to be high for

welfare improvement and is therefore assumed to be of a stronger effect to the dependent

variable, the GINI. On contrary inflation and unemployment rate need to be of a lower value

in order to have a positive effect on the GINI. Data on the access to education was not

available for all countries, only 34 countries in the dataset posses the information of access to

education.

Finally it is important to filter outliers out of the sample, therefore will all variables be filtered

for values outside the region of 3 standard deviations of the mean. Especially a variable as

inflation might be misleading as hyperinflation in one country affects the mean in a

unrepresentative manner.

21
Chapter 4: Descriptive statistics

The world bank defines 116 countries as developing country. Due to the missing foreign bank

data 62 countries are excluded and by the lack of the GINI index another 11 countries are

excluded. The gathering of data proofed to be harsh because developing countries often lack

statistics or the data is very unreliable. The total database consists of 43 countries divided

over 5 continents.

Table 2. Countries divided over continents

Continent Number of countries Percentage as total

Africa 21 48,84%
Asia 12 27,91%
Europe 4 9,30%
North-America 4 9,30%
South-America 2 4,65%
Total 43 100%

Remarkable is the impact of the geographical location of the developing countries on several

variables. Graph 1 and 2 show the 5 different continents in relation to the mean life

expectancy at birth respectively in the year 2004 and the year 2007. The developing countries

in Africa have a mean life expectancy that is around 20 years lower than the developing

countries in the other continents in 2004 and 2007. This might be explained by problem of

HIV, which results in a high mortality rate. Furthermore is the HIV problem leading to a high

child mortality, which is of a huge negative influence of the life expectancy at birth.

22
Graph 1. Graph 2.
Continent in relation to life expectancy 2004 Continent in relation to life expectancy 2007

Graph 3 and 4 show the continental location of the developing countries relate on average to

different levels of foreign banking, both in the year 2002 as 2005. African developing

countries and South-American developing countries have on average higher foreign bank

penetration than the developing countries in other continents. Remarkable is the growth in

foreign bank penetration in North-America in the underlying period.

Graph 3. Graph 4.
Continent in relation to foreign banks in 2002 Continent in relation to foreign banks in 2005

The different geographical locations also reflect different GINI values, the dependent

variable, in both years. Graph 5 and 6 show that developing countries in North-America as

23
well as in South-America have on average a substantially higher GINI value than developing

countries in other continents. The graphs show that het chart of North-America changes the

most, just as the graphs concerning the relation of continents to foreign banks, comparing

2004 with 2007. One might argue that these 4 graphs could indicate a negative effect of the

foreign bank penetration on the GINI for North-America, but for a sample of 4 countries this

effect does not proof to be significant.

Graph 5. Graph 6.
Continent in relation to mean GINI in 2004 Continent in relation to mean GINI in 2007

The foreign bank penetration proofs to be correlated to the inflation 2 years later, as well with

the life expectancy at birth 2 years later. Both these correlations are significant at a 0.05 level

at foreign banking penetration in 2002 and the other variables at 2004 and both these

correlations are significant at a 0.01 level when concerning foreign banking in 2005 in

relation to the variables in 2007. Table 3 and 4 show these correlational relationships for both

time spans. In all the cases there is a negative correlation, so an increase in foreign bank

penetration would be of a negative influece to inflation and life expectancy at birth. Whereas

the negative effect on inflation is a more desired effect than the negative effect on life

expectancy on birth. The negative effect on life expectancy at birth is hard to explain within

24
the current model. The correlational effect might be explained by a stationary health care level

in developing countries whereas an economic development, especcially the liberalization of

the economy, occurs.

Table 3. Correlation Foreign bank penetration * inflation

2002-2004 Foreign bank penetration inflation

Foreign bank penetration 1 -0,377
Inflation -0,377 1

2005-2007 Foreign bank penetration inflation

Foreign bank penetration 1 -0,418
Inflation -0,418 1

Table 4. Correlation Foreign bank penetration * Life expectancy at birth

2002-2004 Foreign bank penetration Life expectancy at birth
Foreign bank penetration 1 -0,377
Life expectancy at birth -0,377 1

2005-2007 Foreign bank penetration Life expectancy at birth

Foreign bank penetration 1 -0,418
Life expectancy at birth -0,418 1

Foreign bank penetration also proofs to be correlated with the depended variable, but only for

the latest time span. This correlation is positive and is significant at a 0.05 level. See table 5

below.

Table 5. Correlation Foreign bank penetration in 2005* GINI 2007

Foreign bank penetration GINI

Foreign bank penetration 1 0,333
GINI 0,333 1

Furthermore there is a significant increase in the mean of foreign bank penetration in the

developing countries over the period 1995 until 2005. A sample T-test shows that the mean

value of the foreign bank penetration in 1995 is located below the 95% confidence interval of

25
the difference of 2005. In Table 6 shows the means of foreign bank penetration in the year

1995 until 2005 as well as the standard deviation. The mean has a upcoming trend and the

standard deviation has a trend downwards, so a leveling in foreign bank penetration in

developing countries occurs. A note hereby is that 5 countries never internationally liberated

their financial markets as their foreign bank penetration stays for the entire period at 0

percent.

Table 6. Mean foreign bank penetration in percentages concerning the period 1995-2005

Year Mean foreign bank penetration Standard deviation

1995 27,60 35,38

1996 29,14 33,98
1997 29,44 33,21
1998 28,47 33,24
1999 31,04 33,65
2000 35,30 32,68
2001 36,30 32,87
2002 37,26 32,67
2003 38,86 32,69
2004 37,60 30,23
2005 38,41 29,48

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Chapter 5: Results

The difference in foreign bank penetration related to the difference in the GINI coefficient does

not have a significant correlation, neither for all the developing countries nor a single segment of

the developing countries, so an impact in relation to the increase of foreign bank penetration may

not be concluded. The beta‟s might give an indication of the possible effect, so below the

regression output is briefly discussed.

Log value of the GINI index α + β1(foreign bank assets/total bank assets at t-2) +

β2(unemployment rate at t)+ β3(inflation at t as from the year 2000) + β4(life expectancy at birth

at t)+ β5(access to education at t).

Table 6. Regression output of the model with the Log value of the GINI index in 2004

Variable Beta Sigma

Foreign bank assets at t-2 0,201 0,307

Unemployment rate -0,052 0,796
Inflation -0,153 0,657
Life expectancy 0,147 0,474
Access to education -0,027 0,888
The model had a R square of 0,043.

Table 7. Regression output of the model with the Log value of the GINI index in 2007

Variable Beta Sigma

Foreign bank assets at t-2 0,285 0,164

Unemployment rate -0,114 0,735
Inflation -0,103 0,598
Life expectancy 0,128 0,544
Access to education -0,071 0,719
The model had a R square of 0,081.

The tables show a consistent view of the beta‟s, the inflation, unemployment rate and access to

education beta‟s are in both time spans negative and the other variables betas are in both time

spans positive. With the R square of the 2007 model almost twice the value in 2004.

27
The results show that foreign bank penetration has the largest betas in both time spans, so

possible a strong effect on the GINI, although this effect doesn‟t proof to be significant. The

strong positive beta might support the literature stating that though an improved access to

credit might lead to welfare improvements (Claessens et al. 2001). Furthermore the negative

betas of the access to education are remarkable, as the expectation was a positive relationship

with the Log value of GINI.

Inflation has an expected negative beta in both time spans. Li and Zou (2002) proof

significant effects of inflation (1) worsening income distributions; (2) increases the relative

income share of the upper class; (3) reduces economic growth. The GINI index is used in the

measurement of the income distributions; therefore the model was likely to be supporting Li

and Zou.

The beta of the unemployment rate is in both time spans negative and becomes in the 2007

model the largest negative beta within the model. Marx, Vandenbroucke and Verbist show in

their discussion about the effect of employment on poverty within the EU a reduction of the

poverty as the employment rate rises, but this is relatively small. Much depends on the income

distributions in the newly created jobs.

Life expectancy has a positive beta in both time spans. The theory was somewhat unclear

about the effect of life expectancy on the welfare level as there were positive relations as well

as negative relations (Acemoglu, Johnson 2007). These betas might indicate that the absolute

welfare improvements are stronger than the population growth, so that there is a relative

welfare improvement.

28
Chapter 6: Conclusion and discussion

The main finding is that there is not a significant relationship between foreign bank

penetration and the welfare level in developing countries. The absence of a significant

conclusion is in all probability caused by the lack of proper data. For 72 developing countries

information about foreign bank penetration and / or the GINI coefficient was not available,

therefore it would be hard to conclude something over developing countries because the

dataset consists of the remaining 43 developing countries. There are several ways that might

lead to significant relationships. Data covering all the developing countries would be good for

both the recognizing of potential significant relationships as well as the reliability of the

generality of potential conclusions. In addition to an increase in the number of countries

information covering more years is assumingly helpful. The current database allows no

opportunity for a panel study covering a time span of successive years; therefore t tests were

made with two years as benchmark with a period of 3 years in between.

With a panel study covering successive years the probability to recognize a significant trend is

more likely.

In addition to current variables other variables, both economic as non economic will correct a

possible effect of foreign banks to the level of welfare to a more accurate level as the model

will explain more of the dependent variable than in the current state. With the addition of

more variables to the model the focus on reverse causality should be high as this might lead to

misleading conclusions. Furthermore corrections for corruption and the persistence of several

of the variables would be possibly of a positive influence of finding a significant relationship.

Corruption is stated in several researches to be of an influence as well mentioned in the

literature review. The variables covering development are likely to be persistent, a larger data

set covering panel data for a substantial time span reduces this effect but in addition a

29
correction can be considered as this is a topic is a actual topic for research.

The existing literature on the effect of foreign bank penetration on economic growth and the

shown correlation between foreign banks and development variables as inflation indicate a

possible relationship between foreign banks and the level of welfare in developing countries.

Further research is desired on this topic.

30
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