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Banking on Growth: The Role of Foreign Banks in Emerging Markets

Foreign bank penetration in emerging markets has been a growing trend in the last three decades as developed and developing countries increasingly seek to liberalise their financial systems toward attaining growth outcomes for their respective economies.

The swelling appetite emerging markets have for international capital flows, technological innovation in the financial sector, and sustainable trade links mean this trend shows no signs of slowing – with banks also remaining eagle-eyed for opportunities to generate higher returns than their home markets can offer.

The relationship between the two is therefore symbiotic and, when managed effectively, can maximise the gains for the bank as well as the markets in which they operate.

The Model

The share of foreign banking offices in host banking system assets has generally remained stable (excluding Correspondent Banking Services) since the Global Financial Crisis more than a decade ago, with shifts from advanced to emerging market economy parents, and from subsidiaries to branches.

As relationship-driven institutions, banks possess proprietary information about their clients’ financial needs which cannot be traded on markets; but is leveraged by the institution possessing it to gain a competitive advantage over local banks when arranging tailored services, like funding solutions at more competitive pricing.

Foreign banks are therefore compelled to adopt the ‘follow the client’ hypothesis which requires opening an office – be it a branch or subsidiary – to better serve the foreign operations of their domestic corporate and defend their unique relationship with clients. This model – focused on corporate and investment banking – delivers international services through offices that are largely wholesale-funded and legally part of the parent.

Trade links are another catalyst for foreign bank penetration in emerging markets – these financial institutions often seek out opportunities to facilitate cross-border trade between their clients by increasing the availability of external finance, among others.  

The Benefits

Like any other industry, healthy competition among financial institutions sparks diversification and innovation.  

For the local sector, the entry of foreign banks has been shown to exert pressure on their domestic counterparts to become more efficient and competitive. It is likely too that foreign banks bring with them better management efficiencies and governance structures, newer technologies, and contemporary financial products and services which have a spill-over effect in the domestic market. This fosters improvement in the management of domestic banks, the quality of their human capital, and the competitiveness of the products they offer.

For emerging market economies, foreign bank penetration offers additional capital, risk management, and liquidity in the market – all of which directly generates capital accumulation and accelerates long-term economic growth. Foreign banks have often provided economies with greater access to international financial markets to fund themselves, raise capital via offshore listings, develop cross-border trade, and stimulate Foreign Direct Investment. Foreign banks are also better able to repackage and sell domestic risk through their wider access to global capital markets and international liquidity.

For clients, the presence of foreign banks can increase the availability of external finance for exporting firms, alleviate financial constraints, improve access to credit, and lower borrowing costs – an important tool for cross-border and local trade in emerging markets.

This becomes increasingly significant when considering opportunities presented by the African Continental Free Trade Area, with banks spanning several countries better able to assist importers and exporters with solutions to mitigate a variety of risks, such as payment risk, performance risk and exchange rate risk, as well as working capital solutions to assist importers and exporters with their cash flows.

Africa’s biggest lender by assets, Standard Bank, which has a presence in 20 countries on the continent, is a prime example. Through its multi-market penetration, the bank’s immense correspondent network is much more poised than domestic banks to offer a deep understanding of local markets, knowledge of regulatory conditions, and the ability to facilitate trade seamlessly on both the import and export side of the same transaction.

The Risks and Policy

While the benefits of foreign bank penetration in emerging economies are widely noted, there do exist some risks, which through appropriate policy implementation, can be mitigated.

In the South African market, for example, decisions taken in the boardroom on risk appetites for a country or region can have an impeding effect on the provision of both correspondent banking and banking services in the domestic market. South Africa has seen the scaling back of operations in the local market with the decision to cease providing both correspondent banking and banking services due to perceived higher risks in AML, KYC, and Financial Crime.

There is also the risk of capital flight and low levels of market stickiness, with foreign banks perceived to easily remove themselves from domestic markets when economies drop into recession. Then, there is the question of competition, with local markets often deterred by foreign banks creating monopolies through greater banking concentration in an economy.

There is a strong case for policymakers to design regulations that promote foreign bank entry to achieve economic and financial development and inclusion while mitigating against perceived risks that may have an ill effect on domestic banks.

With emerging markets continuing to liberalize their financial systems, foreign banks will play an important role in maximizing gains in local economies. But with this comes the need for appropriate policies to assess the cost to benefit tradeoffs and minimize foreseeable risks to the domestic market. 



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