3.1 Introduction

In this chapter, the aim is to promote new lines of research necessary for regulators and bankers through a literature analysis and the description of data. The opportunities that banks can seize from foreign markets depend on several factors, but in the literature there is a recurrent reference to the distance between the country of origin and the country of destination. A short distance increases the probability of obtaining benefits from banking activities abroad.

The literature’s interest in the integration process of European countries does not address the differences they have in terms of the development of their financial or banking systems in a descriptive way. This simple analysis is necessary since these values have an impact on how bank behaviour evolves after deregulation and following crises.

It is not clear if shadow banking is really a driver or if it is followed more in countries with high levels of regulation as an avoidance strategy , or in low-regulation countries due to the fact that weaker regulation makes it easier to carry out such activities . The lack of regulation implies high risks and these are described in the following sections.

Financial integration in European countries is measured using the integration between organizations in the region. This means that, on the one hand, authorities facilitate cross-border deals and, on the other, it is not possible to evaluate the impact of financial integration between countries on international deals, since other factors are more important. It is useful to investigate how the variables of the financial systems of different countries evolved during the years of increasing integration acts by European authorities. In conclusion, there are many topics on which the literature needs to undertake further study.

3.2 Opportunities from Foreign Countries

The literature is rich in descriptions of the various factors driving the entry modes and types of internationalization deals . Hryckiewicz and Kowalewski (2010), for example, find that economic determinants and distance are key factors in finding opportunities and designing the right entry mode . The economic determinants are predictable, but the distance is the factor that has contributed most to rethinking globalization in terms of actual benefits. Geographic distance is a problem when it is long but, in periods of crisis, it may be useful (Cerutti and Claessens 2017) if the bank’s child (branch, subsidiary or newly acquired bank) is in a more stable country .

In general, it is not easy to evaluate the actual benefits from international strategies and involvement in cross-border deals for each bank or firm. Consequently, it is difficult to list with accuracy the opportunities from which a bank can obtain an improvement as a result of its own activity. An analysis by country helps to show the opportunities in each different context. Buch (2000) points out that German banks are driven by the desire to follow their own clients in order to pursue opportunities in their home countries by increasing their profits or avoiding the loss of clients in the domestic market. The financial needs cycle of the firm requires the presence of bank services to make internationalization possible from the finance side (Sist 2014). Many studies investigate the relation of trade and the internationalization of banks between two or more countries, while Williams (1998) finds that higher fees and margins have led the Australian banks to go abroad.

The benefits should be measured in comparison to costs, as suggested also in Niepmann (2015), since in the internationalization process the shape of costs (or investments) is exponential and only after a period and a given level of expenditure does it become logarithmic. Opportunities are key for a bank’s choices in cross-border banking for Niepmann (2015), who discerns three types of banking aboard. In his study, the trade model helps to explain the preference for international banking, foreign sourcing or global banking. He describes how opportunities should come from differences in the banking sector among countries. International banking is preferable when the bank raises financial resources in its own market and lends money in the foreign country , while global banking is chosen when the foreign bank prefers to enter a market in order to intermediate between depositors and the client. In this case, the need for a deal arises, as in the case of foreign sourcing. This last case also creates the need for agreements when the bank lends to clients in the domestic market and when foreign depositors keep their money in the branch or subsidiary. It confirms Williams’ (1998) results in markets different from Australia. Recently, a study assigned the importance for capital flows to supply, not lending, factors, which are stronger in particular for global banking (Cerutti and Claessens 2017).

The structure of the banking sector offers other explanations: in fact, poorly developed financial systems and restricted access to financial services attract foreign banks (Hryckiewicz and Kowalewski 2010). The differences in the banking sector among European countries are pointed out in Graph 3.1, where the variable representing the proportion of deposit money to central bank assets is the size of the banking systems of the European countries. The size of banking systems is the proxy for financial development, where higher levels imply greater financial development (King and Levine 1993).

Graph 3.1
figure 1

Size of the banking system in European countries in the year of Euro currency introduction, before the crisis and in the last year available. Source: World Bank data, author’s elaboration. Note: Deposit money bank assets to deposit money bank assets plus central bank assets (%). Kosovo data are not available

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The most evident results show the different trends between Euro and non-Euro countries. On average, Euro countries have decreased the size of their banking systems (Graph 3.1), while countries outside the Euro area show higher levels of financial development.

The development of the banking sector is a relevant factor for the internationalization of a bank. If this level of development is high, Pozzolo and Focarelli (2001) find a higher probability of making an arrangement to this end. Opportunities arise from the regulation and integration of markets, especially if the countries of origin and of destination are both in a given region, since regulatory acts may have an impact on the choices of the bank, in particular on the organization of the entry mode chosen (Annex B).

3.3 Regulation and Reforms

In the first years following the crisis, my main research question was: how will the banks react to an increase in regulation ? Will they prefer to operate in countries with low regulation levels? Will banks prefer to increase or decrease investments in foreign countries? Some important results emerge from the analysis of the importance of regulation in international banking in Europe and its impact on capital flows to Central and East European (CEE) countries from Western European countries.

Countries need foreign banks in order to obtain benefits from opening their markets. This absolutely conditions bank behaviour, given the institutional theory of internationalization. Banks are not attracted by weak regulation and lax supervision, since the risk from regulation arbitrage may be too high (World Bank 2017/2018). The parent risk sharing with affiliates reduces the expected benefits of banking abroad and the bank must renounce investing in high-risk countries (e.g. low-regulatory countries) to avoid higher negative effects than an investment abroad, especially during local recessions. This important finding supports the efforts to reform financial systems in CEE countries, since regulatory reinforcement needs strong institutional backing. The European Bank for Reconstruction and Development (EBRD) assigns a score to describe the level of reforms applied in a given country . In countries with a weak institutional environment, reforms aim to enact higher levels of regulation, which open markets to foreign ownership (Graph 3.2). Only Albania, Poland, Romania and Slovakia have shown a decrease in foreign ownership, while in the other countries the percentage increased when the banking sector was reformed. This score,Footnote 1 from 1 to 4+, corresponds to the asset share of foreign-owned banks : when it is high or when it increases, so too does the asset share, except for Latvia, where as foreign ownership increases (the other variables are the number of foreign-owned banks , asset share of state-owned banks , asset share of foreign-owned banks , non-performing loans, domestic credit to the private sector or to households, stock market capitalization, stock trading volume and Eurobond issuance, see Annex A).

Graph 3.2
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Comparison of the EBRD index in the banking sector and foreign ownership in 2004, 2007 and 2009 in CEE countries. Source: Author elaboration on EBRD data

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The components of the scores relate to:

  • Market structure (35%): of which degree of competition (43%), ownership (29%), market penetration (14%), resource mobilization (14%)

  • Market supporting institutions and policies (65%): of which development of an adequate legal and regulatory framework (40%), enforcement of regulatory measures (50%), corporate governance and business standards (10%).Footnote 2

Deals are influenced by the effectiveness of banking regulation and are favoured by elements such as culture, distance or institutions. From the point of view of the banks , the assessment of whether they should enter a given country means analyzing the scenario in order to understand the position of governments on the foreign ownership of banks . For example, governments may prefer diversification in the models of bank income, they would like to manage the speed of incoming foreign banks and may wish to increase competition, efficiency and access to credit (World Bank 2017/2018). After these hurdles have been cleared then it is useful to understand which instruments may be applied by countries.

In a more integrated financial system, regulation creates negative spillover effects on the countries in a given region. This is significant if regulation is internationally coordinated in dealing with the supervision (Claessens and Van Horen 2015). Integration is seen as the result of deregulation and it subsidizes intra-EU asset holdings (Buch 2003).

The period of deregulation of financial systems in European countries, as well as in the United States, during the 10 years before the 2007 financial system, favoured financial integration and cross-border activity. The perception of risk at that time was different: in those years, European policy tended to encourage the creation of alliances through the harmonization of rules on ownership (Directive 2007/44/CE)Footnote 3. This directive reduced barriers if the single governments of the European countries involved did not oppose this. In fact, the problem was that this was not accompanied by the opportunity to review costs (such as layoffs) to the organization under the new ownership structure (Hernando et al. 2009). The changes expected from this are an increase in the frequency of regional deals and the acquisition of some kinds of banks . At the end of 2007, there was a fear that a crisis was developing and spreading from the United States.

The situation changed following the emergence of the crisis in Europe. Initially, Basel issued measures aimed at reminding banks that they have a business risk which can manifest itself in different ways, risks caused by certain activities which must be absorbed. With the introduction of Basel II, banks were instructed on how to prevent or defend themselves against the negative effects of risk occurrence, essentially pro-cyclicality and the credit crunch. Unfortunately, the risks occurred, weighing down the effects of the liquidity crisis on the most internationalized banks . All these effects required a further revision of the Basel agreement, with the aim of making banks as anti-cyclical as possible and more transparent about their strategies and the management of liquidity, and imposing a constraint on the use of leverage. The implementation of Basel II initially contributed to aggravate the sovereign debt crisis and inhibited financial resources for non-residents from those countries that had entered into financial distress. Subsequently, a process was launched by the European Parliament to harmonize banking rules and thus tighten regulation .

The situation resulted in the creation of the European Banking UnionFootnote 4 in 2012 as a response to the effects of the crisis, introducing a preference for protecting national needs by keeping capital at home. The European Banking Union is based on three pillars: the Single Supervisory Mechanism, the Single Resolution Mechanism and the European Deposit Insurance scheme. As a result, this should not allow the cost of any bank crisis to fall on the general population.

These actions by the European Parliament have given an impetus to achieving a greater level of integration in the European region, but it is difficult to understand the impact they have had on international activities .

Another process aimed at integrating European financial systems is the Capital Market Union (CMU).Footnote 5 This process took shape following the financial crisis with the aim of creating alternative financial sources for banks at a regional level. Consequently, it involves a revaluation of the long-term relationships between firms (small and medium) and banks , with the intention of wanting to give back to banks the role of specialized intermediaries,. An additional purpose is to enact an adequate discipline of sovereign risk, as long as the supervisory mechanism will respond to needs.

We now need to look at the current situation of the stock and bond markets in European countries. Certainly, if one looks at the capitalization to gross domestic product (GDP) ratio of European countries, only Luxembourg, Sweden and the UK can be compared to the US market. This requires us to ask if these countries are willing to lose this role in order to rebalance and increase the capitalization of other countries, or if the European Union is too expensive (Graph 3.3)

Graph 3.3
figure 3

Market capitalization, Value at the end of the period, Percentage of GDP. Note: Data for EE, LV, LT, SE, FI are not available. Source: Eurostat

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3.3.1 Annex A?

Regarding the reregulation process, it is reasonable to think that risk could occur in the use of shadow banking. Not having to formally manage the risks inherent in the activity of international banking or even shadow bankingFootnote 6 may be one of the drivers.

3.4 Financial Integration of Markets

The integration of banking markets in Europe is a component of financial integration, which is in turn an element of the single market. Financial integrationFootnote 7 is of interest to many sides of the internationalization process. It is always a policy that facilitates international banking among the countries of a region. In particular, the quantity of deals between organizations of the countries involved in integration is used as an indicator of the reaction of firms to the integration steps. While many papers have been published on the impact of the Euro, few have examined that of the Banking Union (BU) and even fewer are about the Capital Market Union. These three main steps in the integration of financial systems imply different consequences in the banking sector and in international activities .

A document from the European Central Bank (ECB) (Baele et al. 2004) attempts to measure the trend of financial integration through an analysis of five separate areas: money markets, government bond markets, corporate bond markets, bank credit markets and equity markets. The three main benefits expected are greater risk sharing and diversification, a better allocation of capital among investment opportunities and higher economic growth.

A measure of the effects on activities across countries can be made by looking at the reduction of barriers over time in the credit and money markets:

  • A high level of cross-border loans and interbank loans, which suggests a more open credit market for foreigners;

  • resorting to the Eurosystem credit and deposit facilities by banks ;

  • the allocation of liquidity across the Euro area;

  • the use of repo with non-domestic partners ;

  • the use of non-domestic collateral originating in other Euro area countries.

The bank credit market results show fragmentation in the retail banking segment in 2004, but the current situation is unclear. The question of reporting system confirms that the integration of two countries facilitates the entry of a bank in the foreign country since the regulation on reporting systems is similar to the rules of the home country (Tsai et al. 2011). To what extent are the countries aligned in terms of bank stability and credit allocation? Focusing on banking, the data on stability are a proxy for measuring the risk trend in European countries,Footnote 8 The World Bank database supplies data useful for this, including: bank Z-score, bank non-performing loans to gross loans (%), bank capital to total assets (%), bank credit to bank deposits (%), bank regulatory capital to risk-weighted assets (%), liquid assets to deposits and short-term funding (%), provisions for non-performing loans (%), stock price volatility (the score for each country and each variable in the years 2002, 2007 and 2015 are available in Annex A). In Graph 3.4, the Z-score consolidated in the banking sector by country is reported, where a higher score means higher stability. In the comparison across countries given in Graph 3.5 on non-performing loansFootnote 9 the data show how Euro countries suffer more than other countries.

Graph 3.4
figure 4

Bank Z-score. Source: Author elaboration of World Bank database

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Graph 3.5
figure 5

Non-performing loan (NPL). Source: Author elaboration of World Bank database

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Just as the trend in European banking stability gives an idea of the impact of financial integration , credit allocationFootnote 10 shows that such aims are attainable. Credit allocation (Graph 3.6) shows the depth of financial system integration. The depth of financial system integrationFootnote 11 (Graph 3.7) is higher following the adoption of the Euro by consumers in all countries except in Luxemburg and Denmark.

Graph 3.6
figure 6

Credit allocation. Source: Author elaboration of World Bank database

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Graph 3.7
figure 7

Financial system deposits to GDP (%). Source: Author elaboration of World Bank database

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In general, cross-border banking is affected positively by participation in the single currency. In fact, the intra-Euro banking sector links show an increase in banks ’ foreign assets and liabilities (Blank and Buch 2007). These connections are directly affected by market size and inversely by distance . Allen and Song (2005) describe a very interesting phenomenon, pointing out that Europe is a region where financial institutions traditionally arrange deals with other European financial institutions. After the establishment of the European Monetary Union (EMU), their behaviour has not changed: integration in the region has increased, while global integration in general has decreased. The expected pan-European dimension of banking is taking form (Vander Vennet and Gropp 2003). Yet the resulting increase in efficiency is partial since different types of barriers to cutting costs still exist. Efficiency enhancement is also partial since different types of barriers exist in cutting costs to improve efficiency. However, three dimensions of international integration can be assessed: the applicability of the law of one price; the volume of cross-border banking; foreign direct investment and the market share of foreign banks . It appears that the first dimension is more complicated in retail banking, while the other two dimensions have reached higher levels (Dermine 2003, 2006).

3.5 Conclusions

Studies on opportunities to obtain a double list of determinants and drivers of internationalization through deals from the characteristics of markets of destination and relative opportunities that can be gained from foreign banks are needed. More opportunities should be seized with each deal instead of pursuing another deal and it necessary do this by single country or region since every market is different and the banking structure is composed of specific institutions and different features. Cross-country analyses are useful as drivers in terms of characteristics of the destination country . The ownership topic is relevant to size in explaining different ways to seize opportunities. The alternative processes of deregulation and reregulation characterized the past 30 years giving different meaning to deals in international activity. If, on the one hand, the wish is that foreign banks decide to arrange deals with partners from countries with high regulation, on the other hand the worry about the increase of shadow banking to avoid rules is present. Financial integration is a process in progress and it was first implemented through EMU, then with the Banking Union and continued with the Capital Market Union. However, the analysis of regional agreements shows that there has always been a positive attitude by European banks to agreements and regional internationalization. The Banking Union involves all the countries of the Euro area and welcomes the countries that voluntarily want to join, but it seems difficult for countries with a high capitalization, such as the UK, Sweden and Luxemburg, to join the Capital Market Union.