The entry of foreign banks into emerging markets: an application of the eclectic theory Janek Uiboupin and Mart Sõrg University of Tartu Abstract In the current paper we discuss the applicability of the eclectic theory in explaining the entry of foreign banks into the Central and Eastern European (CEE) markets. We modify the Dunning’s eclectic model by adding the special case of financial liberalization and timing of foreign entry for emerging markets. In the empirical analysis we use a survey based study to analyze the entry process of foreign banks. Bank level data from Bankscope database is also used to analyze the financial advantages of foreign banks. The empirical analysis showed that the eclectic paradigm with modifications to ownership and location-specific advantages is applicable to explain the entry of foreign banks into transition markets. The analysis also indicated that the entry of foreign banks is more intensive during banking crises in the CEE countries. 1. Introduction The internationalization process of firms has been intensively studied since the 1960s. Due to the increase in international capital flows, foreign direct investments and international trade at that time, active development of international banking also began. In the transition countries, international banks have operated only since the beginning of the 1990s, after a significant liberalization of the financial market and elimination of entry barriers. At present foreign banks1 already have more than 60 per cent of the market in the CEE countries. Growing foreign ownership in the banking sector raises several interesting questions about the entry process of foreign banks into transition economies. There are no generally accepted theories to explain the internationalization process of banks in the transition economies and its implications. The main reason for this gap in the literature is that foreign bank entry into emerging market has been actual only with the “third wave” of international banks’ activities during the second half of 1990s (Herrero and Simón 2003, p. 3). There are two main positive theories of the internationalization of banks, namely the internalization theory and the eclectic theory. The internalization theory of multinational banking has its origins in the Coase (1937) theory of a firm. The theory of internalization emphasizes the importance of transaction costs in imperfect markets. Market imperfection is a necessary condition for internalization. Within the internalization framework, the knowledge advantage of a firm becomes a public good within the firm (Williams 1997, p. 74). The application of internalization theory to banking presupposes the defensive approach of banks. The bank-customer relationships A foreign bank is defined as a bank in which more than 50% of the share capital is owned by foreign residents. 1
are unique and market knowledge about clients can be used at low marginal costs in internal markets. Although the internalization theory has been recently well recognized, we suggest that the entry of foreign banks into the CEE countries has been more aggressive than a defensive approach suggested by the internalization theory. Therefore, the aim of the paper is to analyse the applicability of the eclectic theory in explaining the entry of foreign banks into the Central and Eastern European (CEE) markets. The reminder of the paper is structured as follows: first, we describe the essence of the eclectic theory; then in section three we apply the eclectic theory to the banking sector in the transition countries and suggest some modifications; next, in section four an empirical analysis of foreign banks’ entry motives, ownership advantages and timing is carried out; finally conclusions are presented in section five. 2. The eclectic theory There are many theories which try to explain why firms start to internationalize. Although there is a growing body of literature on FDI, there is no comprehensive approach...
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