Foreign-Owned Banks: The Role of

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 ▼
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FOREIGN-OWNED BANKS
The Role of Ownership in Post-Communist
European Countries
▼
▼
▼
▼
▼
▼
▼
▼
▼
Małgorzata Iwanicz-Drozdowska,
Paola Bongini, Paweł Smaga
and Bartosz Witkowski
▼
▼
▼
STUDIES IN ECONOMIC TRANSITION
General Editors: Jens Hölscher and Horst Tomann

▼
 Studies in Economic Transition

Series Editors
Jens Hölscher
The Business School
Bournemouth University
Bournemouth, East Sussex, UK

Horst Tomann
Department of Economic Policy and Economic History
Freie Universitaet (FU) Berlin
Berlin, Germany
This series brings together theoretical and empirical studies on the
transformation of economic systems and their economic development.
The transition from planned to market economies is one of the main areas
of applied theory because in this field the most dramatic examples of
change and economic dynamics can be found. It is aimed to contribute to
the understanding of specific major economic changes as well as to advance
the theory of economic development. The implications of economic policy
will be a major point of focus.

More information about this series at

http://www.palgrave.com/gp/series/14147
 Małgorzata Iwanicz-Drozdowska
Paola Bongini • Paweł Smaga
Bartosz Witkowski

Foreign-Owned Banks
The Role of Ownership in Post-Communist
European Countries
Małgorzata Iwanicz-Drozdowska Paola Bongini
SGH Warsaw School of Economics University of Milano-Bicocca
Warsaw, Poland Milan, Italy

Paweł Smaga Bartosz Witkowski

SGH Warsaw School of Economics SGH Warsaw School of Economics
Warsaw, Poland Warsaw, Poland

Studies in Economic Transition

ISBN 978-3-030-01110-9    ISBN 978-3-030-01111-6 (eBook)
https://doi.org/10.1007/978-3-030-01111-6

Library of Congress Control Number: 2018960399

© The Editor(s) (if applicable) and The Author(s) 2018

This work is subject to copyright. All rights are solely and exclusively licensed by the
Publisher, whether the whole or part of the material is concerned, specifically the rights of
translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on
microfilms or in any other physical way, and transmission or information storage and retrieval,
electronic adaptation, computer software, or by similar or dissimilar methodology now
known or hereafter developed.
The use of general descriptive names, registered names, trademarks, service marks, etc. in this
publication does not imply, even in the absence of a specific statement, that such names are
exempt from the relevant protective laws and regulations and therefore free for general use.
The publisher, the authors and the editors are safe to assume that the advice and information
in this book are believed to be true and accurate at the date of publication. Neither the
publisher nor the authors or the editors give a warranty, express or implied, with respect to
the material contained herein or for any errors or omissions that may have been made. The
publisher remains neutral with regard to jurisdictional claims in published maps and
institutional affiliations.

This Palgrave Macmillan imprint is published by the registered company Springer Nature
Switzerland AG
The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland
 Contents

1 Introduction  1
Bibliography  3

2 CESEE Countries: Historical Background, Transition, and

Development  5
2.1 A Brief History of CESEE Countries  5
2.2 Economic and Political Transition  7
2.3 How Developed Are CESEE Countries? 11
2.4 What Are the Development Driving Forces? 15
Bibliography 17

3 Foreign Bank Entry into CESEE Countries in the 1990s

and Afterwards 19
3.1 Why Did Foreign Banks Decide to Enter? 19
3.2 Entry Strategies and Organizational Forms 41
3.3 Performance of Foreign-Owned Banks 47
3.4 Conclusions 59
Bibliography 60

4 Credit Activity of Foreign-Owned Banks in CESEE 65

4.1 What Drives Credit Growth in CESEE? 65
4.2 Are Foreign-Owned Banks More or Less Procyclical than
Domestic-Owned Banks? 78
Bibliography 84

v
vi Contents

5 Impact of Foreign-Owned Banks on Financial Stability 89

5.1 Global Financial Crisis in the Context of CESEE 89
5.2 Measures of Financial Stability in CESEE Countries121
5.3 Do Foreign-Owned Banks Promote Financial Stability?
Differences Between Foreign-Owned and Domestic-Owned
Banks136
5.4 What Drives Financial Stability in CESEE Banking
Sectors?145
5.5 Financial Stability Outlook in the CESEEs151
Bibliography157

6 Impact of Foreign-Owned Banks on Economic

Development169
6.1 Economic Growth and Financial Development: Theory and
Evidence169
6.2 Finance and Growth in CESEE Countries181
6.3 Is Foreign Bank Credit Growth-Enhancing?191
6.4 Foreign Ownership in CESEE Countries: Evidence from a
Large Sample and Extended Sample Period196
6.5 Conclusions204
Bibliography205

7 Concluding Remarks: Who Is the Winner of Foreign Banks’

Presence?213
Bibliography215

Index217
 List of Figures

Fig. 2.1 GDP and GDP per capita (1995–2016). (Note: Arithmetic
averages in both groups; Source: Based on data from European
Central Bank (ECB) and World Bank) 11
Fig. 2.2 GDP growth (1995–2016). (Note: Arithmetic averages in
both groups; Source: Based on data from ECB and World
Bank)12
Fig. 2.3 Rate of inflation and unemployment rate (1995–2016). (Note:
Arithmetic averages in both groups; Source: Based on data
from ECB and World Bank) 12
Fig. 2.4 FDI inflow to GDP and openness to trade (1995–2016).
(Note: Arithmetic averages in both groups; Source: Based on
data from World Bank) 13
Fig. 2.5 Domestic credit to private sector to GDP and stock market
capitalization to GDP (1995–2016). (Note: Arithmetic averages
in both groups; Source: Based on data from World Bank) 14
Fig. 3.1 Theories of multinational banking. (Source: Based on Rajan
and Gopalan (2014)) 23
Fig. 3.2 Empirical determinants of foreign bank entry. (Source: Adapted
from Rajan and Gopalan 2014) 24
Fig. 3.3 Evolution of foreign bank participation in 1995–2015, by
macroregions. (Source: Own calculation) 42
Fig. 3.4 The relative importance of the retail business. (Note: Retail
business = ratio of customer deposits plus (net) customer loans
over total assets; Source: Own calculation from Bankscope data) 46
Fig. 3.5 Average growth in bank size (1995 = 1), by bank ownership.
(Note: *Starting point is year 1998, as before 1998 the

vii
viii List of Figures

presence of foreign banks was so negligible, it would reduce

comparability of growth rates; Source: Own calculation) 48
Fig. 3.6 Average growth in credit (1995 = 1), by bank ownership.
(Note: *Starting point is year 1998, as before 1998 the
presence of foreign banks was so negligible, it would reduce
comparability of growth rates; Source: Own calculation) 49
Fig. 3.7 Customer deposits growth by bank ownership (1995 = 1).
(Note: *Starting point is year 1998, as before 1998 the
presence of foreign banks was so negligible, it would reduce
comparability of growth rates; Source: Own calculation) 51
Fig. 3.8 Selected performance indicators (1995–2015) by bank
ownership and regional decomposition. (Source: Own
calculation using BankScope data) 53
Fig. 4.1 Development of average credit gaps in the CESEEs for total
banking sector. (Note: Loans (CF)—average credit gaps
calculated using natural logarithms of the annual data for stock
of (gross) loans with a full-length asymmetric band-­pass CF
filter with cycle length 8–20; LHS. Loans (HP)—average
credit gaps calculated using natural logarithms of the annual
data for stock of (gross) loans with an HP filter lambda 1600;
LHS. Credit-to-GDP (HP)—average credit gaps calculated
using annual data for credit-to-GDP ratios with an HP filter
lambda 1560; RHS; Source: Own work) 82
Fig. 4.2 Development of average credit gaps in the CESEEs for banks
with different type of ownership (CF). (Note: Average credit
gaps calculated using natural logarithms of the annual data for
stock of (gross) loans with a full-length asymmetric band-pass
CF filter with cycle length 8–20; Source: Own work) 83
Fig. 5.1 Development of banking systems and the share of foreign-
owned banks pre-GFC in selected CESEEs. (Note: Average
credit-to-GDP ratio (2000–2008)—horizontal; average market
share of foreign-owned banks to total assets (2000–2008)—
vertical; Source: Own work based on data from World Bank,
Federal Reserve Economic Data, Helgi Library, and national
central banks) 90
Fig. 5.2 Assets of Monetary Financial Institutions, stock market
capitalization, and the role of foreign-owned banks (1997–
2016). (Note: Arithmetic averages in both groups of countries.
Based on data from ECB, World Bank, Helgi Library, RBI
Research, and national central banks) 91
Fig. 5.3 MFI’s assets to GDP and GDP per capita (in EUR) in the
CESEE countries. (Note: Arithmetic averages for each country
 List of Figures  ix

for the period of 1995–2016 of countries. Based on data from

the ECB and World Bank) 91
Fig. 5.4 Profitability and capital adequacy during the 1995–2016
period in CESEEs. (Note: Arithmetic averages; Source: Own
work based on data from ECB, World Bank, IMF, and national
central banks) 92
Fig. 5.5 Liquidity ratios and deposits/credits ratio during the 1997–
2016 period. (Note: Arithmetic averages; liquidity ratio equals
liquid assets to deposits and short-term funding; D/C ratio is
455% for 2000 and 323% for 2001; Source: Own work based
on data from ECB and World Bank) 93
Fig. 5.6 Demand- and supply-side drivers of FX lending in the
CESEEs. (Source: Adapted from Simor 2011) 94
Fig. 5.7 Exchange rates of selected currencies in CESEEs. (Note: 2000
Q1 = 100; LHS: CHF/PLN, CHF/HUF, CHF/HRK; RHS:
CHF/RON; Source: Own calculations using data from
Bloomberg)96
Fig. 5.8 Current account deficits in % of GDP in CESEEs. (Note:
Bars—data for 2017; dots—pre-GFC minimum (−50% for
ME); Source: Own calculations using World Economic
Outlook data from IMF DataMapper) 100
Fig. 5.9 Credit-to-GDP ratios in CESEEs 1995–2016 (in %).
(Source: World Bank and Federal Reserve Economic Data) 106
Fig. 5.10 GDP growth rate and credit-to-GDP in the Baltics. (Note:
Average GDP growth rate is weighted with GDP of countries
in the sample. Baltics include EE, LT, LV; Source: Own work
using data from World Bank and Federal Reserve Economic
Data)106
Fig. 5.11 GDP growth rate and credit-to-GDP in the CEE. (Note:
Average GDP growth rate is weighted with GDP of countries
in the sample. CEE includes BY, CZ, HU, PL, SK, SI, UA;
Source: Own work using data from World Bank and Federal
Reserve Economic Data) 107
Fig. 5.12 GDP growth rate and credit-to-GDP in the SEE. (Note:
Average GDP growth rate is weighted with GDP of countries
in the sample. SEE includes AL, BA, BG, HR, KV, ME, MD,
MK, RO, RS; Source: Own work using data from World Bank
and Federal Reserve Economic Data) 107
Fig. 5.13 Example of a cobweb financial stability map—Croatia.
(Source: Croatian National Bank 2016) 127
x List of Figures

Fig. 5.14 Development of asset-weighted average FSI and FSI PCA for
domestic and foreign-owned banks in CESEEs. (Source: Own
work)142
Fig. 5.15 Development of asset-weighted average FSI and FSI PCA and
the average of credit gap for banks in the CESEEs. (Note: FSI
and FSI PCA is LHS and credit gap (CF) is RHS; Source:
Own work) 143
Fig. 5.16 Development of asset-weighted average Z-Scores for foreign-
owned banks in the CESEEs. (Note: Z-Scores 1–3 is LHS and
Z-Scores 4–7 is RHS; Source: Own work) 143
Fig. 5.17 Average level of FSI and share of foreign ownership in the
banking sector pre-GFC (1995 to 2006). (Notes: Due to data
gaps, the data for KV are not shown, horizontal line—average
share of foreign ownership in banking sector assets, vertical
line—average level of FSI) 144
Fig. 5.18 Average level of FSI and share of foreign ownership in the
banking sector post-GFC (2007 to 2014). (Notes: Horizontal
line—average share of foreign ownership in banking sector
assets, vertical line—average level of FSI) 144
Fig. 6.1 Financial Sector Foreign Direct Investments and transmission
channels that affect GDP growth. (Source: Adapted from Eller
et al. 2005) 192
 List of Maps

Map 3.1 Geographical structure of foreign trade vis-à-vis home countries

of foreign-owned banks-year end 2000. (Source: Maps
produced using IMF trade statistics, BankScope data and
hand-collected data) 35
Map 3.2 Geographical structure of foreign trade vis-à-vis home countries
of foreign-owned banks-year end 2008. (Source: Maps produced
using IMF trade statistics, BankScope data and hand-collected
data)37
Map 3.3 Geographical structure of foreign trade vis-à-vis home
countries of foreign-owned banks-year end 2015. (Source:
Maps produced using IMF trade statistics, BankScope data
and hand-collected data) 39

xi
 List of Tables

Table 3.1 Review of empirical literature focusing on CESEE markets 29

Table 3.2 Relative importance of lines of business in CESEE banking
sectors (2004) 46
Table 4.1 Regressors 69
Table 4.2 Estimates of model (1.1) in different samples according to
host bank ownership structure 71
Table 4.3 Estimates of model (2.1) in different samples according to
type of parent with different set of regressors 74
Table 5.1 Credit booms in CESEEs in the twenty-first century 98
Table 5.2 GDP growth rates (current prices, y/y) in CESEEs around
the GFC 101
Table 5.3 List of policy measures to limit credit growth in CEE
(2003–2007)110
Table 5.4 Measures adopted by national authorities in CESEEs as a
response to the GFC 114
Table 5.5 Policy measures to curb FX lending in the CESEEs 118
Table 5.6 Financial soundness indicators: the core and encouraged sets
according to the IMF 125
Table 5.7 Variables used to calculate the FSI 140
Table 5.8 Independent variables included in the model of the direction
of the Z-Score change (year over year) 146
Table 5.9 Descriptive statistics 148
Table 5.10 Estimates of the direction of change in Z-Score logit model
determinants on country-level data 149
Table 6.1 Review of theoretical literature on finance and growth 171
Table 6.2 Financial development index 177
Table 6.3 Review of empirical literature in CESEE countries 182

xiii
xiv List of Tables

Table 6.4 Share of foreign ownership in CESEE countries as of 2015

(2017)197
Table 6.5 Definition of variables 198
Table 6.6 Estimates of Eq. (6.2)—models 1.1–1.5 202
 CHAPTER 1

Introduction

Małgorzata Iwanicz-Drozdowska

The role and market behaviour of foreign-owned banks have been anal-
ysed for both well-developed countries (e.g. Peek and Rosengren 1997,
2000; Sturm and Wiliams 2008) and emerging markets (e.g. Cull and
Martínez-Pería 2013; Havrylchyk and Jurzyk 2011). The presence of
foreign-­owned banks as well as cross-border activity of international banks
is attributable to the liberalisation of capital flows and globalisation. In this
book we focus on foreign-owned banks, not the cross-border activity of
international banks. However, in order to present a broader picture, we do
refer, whenever needed, to studies in both veins. Financial sectors in
Central, Eastern, and South-Eastern Europe (CESEE) are bank-based and
the banking sector was and still is the biggest player on the CESEE mar-
kets and is of crucial importance to the national economy. A comprehen-
sive study covering all the European countries in transition, the results of
which are presented in this book, shows the impact which the openness of
the banking sector to foreign investment exerted over the last two decades
on financial stability, which is a public good, and on economic develop-
ment, which is crucial in the further catching-up process.
After the collapse of the communism in CESEE (these countries are
also called post-communist countries or countries in transition), these
markets opened to international cooperation and investments restoring
their links with the Western world. After the initial reforms shifting the
countries towards the market economy, which were severe to their

© The Author(s) 2018 1

M. Iwanicz-Drozdowska et al.,
Foreign-Owned Banks, Studies in Economic Transition,
https://doi.org/10.1007/978-3-030-01111-6_1
2 M. IWANICZ-DROZDOWSKA ET AL.

s­ocieties, attractiveness of the countries in transition encouraged foreign

­investors to explore investment opportunities in this region.1 One of the
key directions of foreign investment was the financial sector, underdevel-
oped in comparison with the Western countries, and potentially very
attractive due to the catching-up process. International banks entered the
CESEE markets by setting up their subsidiaries or taking over existing
banks, fairly often through the privatisation process.
Until the outbreak of the global financial crisis (GFC) the presence of
foreign-owned banks was regarded as an advantage for the national econ-
omy because foreign investors were treated as a source of stability and a
helping hand for their local subsidiaries. The outbreak of the GFC and
financial troubles faced by many international banks brought concerns
about the transfer of shocks from the parent banks to their subsidiaries and
therefore their role for the CESEE markets. These concerns were caused by
the turmoil on global financial markets, the lack of trust on interbank mar-
kets, and a sudden stop of cross-border financing. Against this background,
our goal is to present the role of foreign capital in the banking sector in
post-communist countries with regard to financial stability and economic
development over two decades. This book presents the results of the study
prepared, thanks to the support of the Polish National Science Centre
(UMO-2014/13/B/HS4/01619), for the project titled “Foreign capital
in the Central and Eastern European banking sectors – the impact on finan-
cial stability and economic development” conducted in 2015–2018.
The analysis of the impact of foreign capital in the banking sector is
important to various stakeholders, including policymakers. While assessing
country’s internal policy and past decisions, one can use the results of our
study as a benchmark. Some CESEE countries are still on a relatively early
stage of the catching-up process, mostly due to the late start of reforms
and/or a long-lasting military conflict. In order to shape their economic
policy properly, it is valuable to know the outcome of other countries’
policies, not only from a stand-alone perspective, but on a cross-section
and cross-country basis.
The book consists of seven chapters. Chapter 1 is of an introductory
character, while Chap. 2 presents a brief history of the CESEE countries,
with special attention paid to the process of economic and political trans-
formation. Chapters 3, 4, 5, and 6 present the state-of-the-art research
based on a review of extant literature and the empirical results of our work.
Chapter 3 shows foreign bank entry in the CESEE banking sectors with
different strategies, as well as the evolution of their presence and their
 INTRODUCTION 3

performance. In Chap. 4, we present the credit activity of the CESEE

banks for different types of owners, including state-owned banks, domes-
tic private-owned banks, and foreign-owned banks. We analyse determi-
nants of credit growth and its procyclicality. Bank credit plays a special role
for financial stability and economic development. Both issues are thor-
oughly analysed in the following chapters. Chapter 5 starts with the
description of the GFC impact on post-communist countries. Before pre-
senting the determinants of financial stability in the region, we analyse
different measures of financial stability, searching for the best one for post-­
communist countries. Chapter 6 refers to the finance-growth nexus, from
both the theoretical and empirical perspectives. We analyse the determi-
nants of economic growth expanding macroeconomic model by financial
sector-specific determinants, including the role of foreign-owned banks.
Conclusions are presented in the last chapter, where we attempt to identify
the winners of foreign banks’ presence in CESEE.
As a project leader, I would like to extend my thanks to my co-authors,
Paola Bongini, Paweł Smaga, and Bartosz Witkowski, for their involve-
ment in the project and intensive work at many stages. Moreover, I would
like to thank Paweł Smaga for his valuable support in editorial works for
this book and my PhD candidates (Łukasz Kurowski and Karol Rogowicz)
for their support in data collection.
We hope this book will be an interesting voice in the discussion on the
role of foreign capital in emerging markets and may help shape the future
economic policy in the CESEE region.

Note
1. We refer to the CESEE countries as host countries, while to countries of
investors as home countries.

Bibliography
Cull R, Martínez-Pería M (2013) Bank ownership and lending patterns during
the 2008–2009 financial crisis: Evidence from Latin America and Eastern
Europe. J Bank Financ 37(12): 4861–4878. https://doi.org/10.1016/j.
jbankfin.2013.08.017
Havrylchyk O, Jurzyk E (2011) Inherited or earned? Performance of foreign
banks in Central and Eastern Europe. J Bank Financ 35(5):1291–1302.
https://doi.org/10.1016/j.jbankfin.2010.10.007
4 M. IWANICZ-DROZDOWSKA ET AL.

Peek J, Rosengren E (1997) The International Transmission of Financial Shocks:

The Case of Japan. Am Econ Rev 87(4): 495–505
Peek J, Rosengren E (2000) Collateral Damage: Effects of the Japanese Bank
Crisis on Real Activity in the United States. Am Econ Rev 90(1): 30–45
Sturm, J, Wiliams, B (2008) Characteristics determining the efficiency of foreign
banks in Australia. J Bank Financ 32(11):2346–2360. https://doi.org/
10.1016/j.jbankfin.2007.12.029
 CHAPTER 2

CESEE Countries: Historical Background,

Transition, and Development

Małgorzata Iwanicz-Drozdowska

2.1   A Brief History of CESEE Countries

Before World War I, Central Europe was under the rule of the Russian
Tsardom, the German Empire, and the Austro-Hungarian Empire. In the
Balkans, there were five separate states—Bulgaria, Romania, Albania,
Serbia, and Montenegro. World War I considerably changed the geopoliti-
cal situation through, among others, the October Revolution and the
post-war treaties. After three partitions and 123 years of inexistence as a
state, Poland gained independence in 1918. National sovereignty was also
gained by the Baltic states (Lithuania, Latvia, and Estonia), Czechoslovakia,
and Hungary, while in the Balkans, Yugoslavia was established. In the
eastern part of Europe, the Soviet Union emerged. The CESEE countries
did not enjoy peace and freedom for a long time, as the year of 1939
brought the outbreak of World War II. Nearly six years of warfare ruined
many economies in CESEE. The post-war order pushed these countries
under the Soviet political and economic dominance and converted their
economic systems into centrally planned economies.
A centrally planned economy lacked an effective interplay between supply
and demand. In each of the countries, for a specific period of time, an exten-
sive central plan determined what was produced and how it was distributed.
The private sector was either totally squeezed out, or virtually non-existent

© The Author(s) 2018 5

M. Iwanicz-Drozdowska et al.,
Foreign-Owned Banks, Studies in Economic Transition,
https://doi.org/10.1007/978-3-030-01111-6_2
6 M. IWANICZ-DROZDOWSKA ET AL.

or played only a minor role on the market. One of the problems that emerged
during the period of communism was the shortage of supply of certain prod-
ucts, including necessity goods. A centrally planned economy was inefficient
in solving such structural problems. Kornai (1980) called this phenomenon
“the economics of shortage”, indicating that this was not the result of the
central planners’ errors or prices set at inadequate levels, but of systemic
flaws. One of the traits of “the economics of shortage” was long queues in
front of shops, with people waiting for the delivery of almost all essential
items. In parallel, because of these shortages, a black market for goods was
flourishing (e.g. food, cigarettes, alcohol, oil, but also foreign currencies),
naturally, with much higher prices than the official (regulated) ones.
After World War II, the Western Bloc was supported by the Marshall Plan
(an American Recovery Plan for Europe established in 1947) to help rebuild
Western European countries, as well as to protect them from the spread of
communism. In order to counterbalance the results of the Marshall Plan,
the Eastern Bloc (excluding Yugoslavia) established the Council for Mutual
Economic Assistance (Comecon) in 1949 (which operated until 1991),
with headquarters in Moscow. It was supposed to stimulate economic coop-
eration, speed up industrialization and technological progress, improve
labour force efficiency, and boost economic development. However, in
practice, these goals were not achieved. In 1962, Comecon decided upon
international socialist division of labour, meaning that each country was
expected to specialize in the production of certain goods.
The Eastern Bloc adopted the Soviet economic model also in its finan-
cial system. Banking and insurance sectors were state-owned, while the
capital market did not exist at all. At that time, central banks played a
peculiar role of a “monobank” (commercial banking and central banking
activities were pursued by a single entity) and were focused on financing
the central plan, for example, by annual credit plans. State-owned banks
and insurers provided services to individuals and state-owned enterprises.
As foreign trade posed specific requirements, some banks were specialized
in foreign-trade transactions, including deals with countries from the
Western Bloc. There was no financial supervision and no deposit protec-
tion schemes, because under the communist system no bankruptcies were
allowed. Kornai (1979), who also introduced the concept of “soft budget
constraints” for socialist countries, showed that socialist firms were bailed
out by state agencies when their revenues did not cover costs.
Starting in the mid-1950s, after the death of Stalin, social unrest fre-
quently sparked off in the region as a result of, for instance, price increases,
food shortages, or the lack of civil liberties. This region’s history is marked
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