IMF Survey: Why did you decide to examine how foreign banks perform relative to domestic banks during financial crises? And why Malaysia?
Detragiache: There has been a lot of foreign bank entry in emerging markets in the past 10 years or so, and many researchers and policymakers are wondering how this will affect the banking sector in these markets. While there have been studies of how foreign bank entry affects market competition, local bank performance, and other factors, we are not aware of any studies that have looked at how foreign banks perform during crises relative to domestic banks. We also thought this would be an interesting topic because there have been many such crises.
Gupta As for Malaysia, one interesting question is whether the presence of foreign banks declines or increases during or just after a crisis. When emerging markets’ financial sectors are liberalized following a crisis, one finds that the number of foreign banks increases because of the liberalization, and this effect cannot be distinguished from the actual effects of the crisis. We chose to look at Malaysia because it has had a sizable foreign bank presence for a long time, provides a typical case of an emerging market crisis, and has good data availability. We were able to obtain macro level as well as bank level data, and we had detailed information on government support to individual banks during the crisis.
IMF Survey: Did foreign banks weather the crisis better than domestic banks?
Detragiache: We found that the sharpest difference was not between foreign banks and domestic banks, but between foreign banks that were mainly active in Asia and those that were not. Some foreign banks—for example, a few from other Southeast Asian countries and two U.K. banks that specialized in Asia—tended to perform more like domestic banks. In contrast, foreign banks from outside the region—for example, certain U.S. and German banks that did not specialize in Asia—seemed to perform better during and following the crisis. This latter group of banks did not see declining profitability; its nonperforming loans increased less markedly; and, in general, its performance indicators were better. This group also experienced less of a decline in deposit growth.
Gupta Aside from banks’ performance indicators, we also looked at whether their postcrisis presence in the market changed and whether they received government support. On market presence, we found the results statistically indistinguishable among the three bank groupings. After the crisis, foreign banks did not reduce their presence faster than domestic banks. However, the results strongly showed less government support for foreign banks—particularly for foreign banks that were more active in Asia despite having high nonperforming loans.
IMF Survey: What do you think explains this difference in behavior between foreign banks that did and did not have an Asia orientation?
Detragiache: There is no obvious explanation, and it probably is still somewhat of an open question. One possibility is that the banks that did not have an Asia orientation received more financial support from their parent banks and therefore were not as affected by liquidity problems as the more locally oriented banks. When we looked at the bank data, however, we saw that the non-Asia-oriented banks had lower amounts of nonperforming loans. So, not only did they have more access to liquidity, they also had better loan portfolios to begin with.
The question then became: why did their loan portfolios perform better? One hypothesis we had was that these banks were lending to multinational corporations. Since these banks were not specialized in Asia, their overall client base would tend to do relatively less business in Asia and thus be more insulated from the effects of the Asian crisis.
Less exposure to risky sectors helped non-Asia-oriented foreign banks
|(percent of total loan portfolio1)|
This seemed plausible, but then we found data showing this was not the full explanation. The sectoral composition of loan portfolios showed that the non-Asia-oriented foreign banks had more manufacturing loans [see table above]. They also were less exposed to the real estate sector and had made fewer loans to finance the purchase of securities by private investors—two trouble spots where most of the loan quality problems were concentrated. The Asia-oriented foreign banks and the domestic banks had relatively high exposure in these two areas. So, clearly, the banks’ different behavior before the crisis explained performance differences after the crisis.
IMF Survey: Why did the banks choose different kinds of portfolios?
Gupta One possible explanation could be moral hazard, although this does not explain why Asia-oriented foreign banks chose to follow a high-risk strategy similar to that of domestic banks. The foreign banks did not receive government support in any significant way. The other possibility is herd behavior.
Detragiache: To elaborate further, the loan portfolio managers of Asia-oriented foreign banks may have chosen to follow the “herd” of bankers in the region who sought to make high profits by investing in risky sectors and, so, became caught up in the speculative bubble along with their peer groups. In contrast, the relevant peer group for bank managers not specialized in Asia may have been different, shielding them more so from risky lending.
This points to good governance within a bank, whether domestic or foreign, as mattering more than access to emergency liquidity. One of the arguments in favor of emerging markets being more open to foreign bank entry is that, in some sense, these countries are able to import sound supervisory rules and practices because it is the home country supervisor that supervises the foreign banks. But we could not find very convincing evidence of this. We should stress, however, that this is just one country case study looking at a small sample of banks, and it would be premature to generalize without further research.
IMF Survey: Thailand’s financial crisis of 1997-98 blurred the once clear division between domestic and foreign banks: four of the five smallest domestic banks came under the control of foreign owners. Did this occur in Malaysia as well, to any extent?
Gupta We looked at very detailed information at the bank level, and we did take into account any big changes in bank history and operations, including mergers and acquisitions. But we did not see this happening in our sample of banks. In terms of whether foreign banks acquired domestic banks and whether that changed the sample in any way, the answer is no.
Detragiache: I do not think there was a policy shift on the part of the Malaysian authorities to let in more foreign banks. But we did not focus in our research on whether the crisis triggered more foreign entry per se.
IMF Survey: Two Singaporean banks, OCBC and United Overseas Bank, emerged in the five years following the crisis in Malaysia to advance into the top ranks. Do you plan to look further at differences in bank performance several years in the wake of crises?
Detragiache: We don’t have immediate plans to do so, but crises lead to major changes in market structure along many dimensions, and the extent to which these changes lead to better performance is a very interesting question in the medium term and awaits an answer.
IMF Survey: Do you or your colleagues have plans to see whether these findings would hold in other countries or regions?
Detragiache: It would depend on whether we could find the right episodes. We originally looked at a larger sample of countries to find countries for which we could obtain foreign bank data. We ended up choosing Malaysia. Since we started our research, there have been a few more episodes of financial market distress—for example, in Uruguay, where the crisis has been different. This could provide another interesting case study.
Copies of IMF Working Paper No. 04/129, “Foreign Banks in Emerging Market Crises: Evidence from Malaysia,” are available for $15.00 each from IMF Publication Services. See page 335 for ordering information. The full text of the paper is also available on the IMF’s website (www.imf.org).