The Defensive Expansion Approach to Multinational Banking: Evidence to Date

The Defensive Expansion Approach to Multinational

Banking: Evidence to Date

by Barry Williams*

This paper integrates the defensive expansion hypothesis in multinational bankingwith the internalisation approach to the multinational enterprise. This framework isthen used to structure a review of the literature to date regarding the proposition thatmultinational banks follow their clients abroad, otherwise called the defensiveexpansion hypothesis. Both theoretical and empirical issues relevant to the study ofthe defensive expansion hypothesis are canvassed. The paper concludes that thedefensive expansion hypothesis is best modelled using firm level data, and thatinvestment measures are a preferred proxy for following clients. Furthermore, studiesconsidering the defensive expansion hypothesis should control for the effects ofparent firm size and economic cycles. The paper concludes that defensive expansionincreases multinational size, but has little impact upon multinational bank profits.There is some evidence that defensive expansion impacts upon the type of organi-sational form adopted by the multinational bank in the host nation.

I. INTRODUCTION

That banks follow their clients abroad is the most pervasive proposition in

multinational banking. This proposition is so omnipresent that it has been

termed the conventional hypothesis (Sabi, 1995). As such, a complete discussion

of both the theory and evidence relating to this hypothesis is relevant in an era of

increased globalisation of financial services. As argued by Seth et al. (1998), the

motives for cross border expansion by banks, and their subsequent performance,

are of interest to bankers, rating agencies and regulators, as well as being the

subject of academic inquiry. Thus, a comprehensive review of the literature that

considers the defensive expansion hypothesis is of value from a number of

perspectives. In particular, integration between the theory of the multinational

enterprise, the defensive expansion hypothesis and the empirical evidence to date

is currently lacking. One of the objectives of this paper is to rectify this gap in the

literature. As argued by Graham and Krugman (1994), the pattern of foreign

direct investment (FDI) in the banking industry differs from that of other

industries. Thus, there is a need to develop an appropriate interface between

theory and empirical evidence to ensure that correct inferences are drawn from

any empirical results. The need to ensure that theory and evidence relating to

*I am grateful for comments from John Foster, Ian Zimmer, Noel Gaston, Art Goldsmith andan anonymous referee. All remaining errors remain the responsibility of the author.

Financial Markets Institutions & Instruments, V. 11. No. 2, May 2002 Ó 2002 New York UniversitySalomon Center, Published by Blackwell, Publishers, 350 Main St., Malden, MA 02148, USA, and 108Cowley Road, OX4 IJF, UK.

multinational banking are well integrated is reinforced by the observation of

Khoury (1997), that the 1990s did not witness the development of any new

theories. Thus, there is a need to ensure that the current body of theory is

thoroughly examined.

Further, this paper will provide a critical review of the empirical studies to

date. This critical review will provide a forum for discussion of the current state

of the literature regarding the defensive expansion hypothesis, while also

providing a basis from which further research can be directed. To date, the

empirical literature that has considered the defensive expansion hypothesis has

lacked a coherent theme. By integrating the evidence as it stands within the

internalisation theory of the multinational enterprise, this paper will provide a

coherent theme to discuss previous results. This coherency will also provide a

framework within which to review the current evidence. This paper will also

consider the issues relevant to empirically modeling the defensive expansion

hypothesis. In particular, the issue of whether trade or investment measures are

the most relevant proxy for defensive expansion will be addressed, as well as

other empirical issues.

This paper will also integrate the taxonomic issues associated with the

delineation between international banking and multinational banking in the

context of the theory of the multinational enterprise. This integration will aid in

the interpretation of some empirical results that may appear contradictory at

first inspection. By addressing this issue the paper will be able to consider the

role defensive expansion has in the substitution between providing international

banking services from the home nation (international banking) and providing

international banking services from the host nation (multinational banking).

This paper is structured as follows; first it will be argued that the study of the

multinational bank should be conducted within the framework provided by the

theory of the multinational corporation. Further, the paper will argue that

internalisation theory provides the framework that allows a coherent unification

of theory with observed outcomes. The second section will discuss the defensive

expansion hypothesis within the framework provided by internalisation theory.

This paper will argue that banking is an industry where information is a key

intermediate product. Buckley and Casson (1991) and Williams (1998) argue

that multinational banking is an industry best discussed within the theoretical

framework provided by internalisation theory due to the importance of

information as a key intermediate product. The third section will discuss the

empirical literature regarding defensive expansion in multinational banking. The

final section will discuss directions for further research.

II. THE MULTINATIONAL ENTERPRISE AND MULTINATIONAL

BANKS

Developments in multinational banking have resulted in banks owning and

controlling activities in geographical locations that are removed from the

128 Barry Williams

ostensible location of that activity.1 Eurobanking produces loans to foreign

entities, denominated in foreign currencies, without the lender leaving its home

nation.2 Seminal studies of the multinational enterprise emphasised the

ownership of assets physically present in a foreign country, particularly in the

manufacturing industries.3 Extending the study of the multinational firm to

circumstances where a physical presence is not required for multinationality is

consistent with a broader definition of the multinational enterprise. Such a

definition is the operational definition of multinationality. The operational

definition considers multinational firms as those that own and control

undertakings in different countries (Buckley and Casson, 1991).4

Edwards (1975) considered participation in the Euromarkets to be multina-

tional banking. Aliber (1977) expanded the definition of multinational banking

to include both Euromarket activity and traditional foreign banking. Tradi-

tional foreign banking was classified as competing with the incumbent domestic

banks in the provision of banking services. Robinson (1972, p. 4) provided a still

broader definition of multinational banking: ‘‘...operating a bank in and

conducting banking operations that derive from, many different countries and

national systems.’’ However, this classification is so broad that it includes

banking activity that can be offered from purely domestic locations, such as

foreign exchange trading and portfolio diversification (Lewis and Davis, 1987).

This paper shall adopt the definition provided by Lewis and Davis (1987, p. 248);

‘‘Multinational banking embraces both the Eurocurrency banking activities of

foreign banks and their banking in host country currencies.’’ This closely follows

the operational approach of Buckley and Casson (1991). It is also consistent

with that provided by Casson (1990, p. 14): ‘‘A multinational bank (MNB) is

simply a bank that owns and controls banking activities in two or more countries.’’

Conformity of the definitions employed for multinational firm versus

multinational bank is important. If a restrictive definition of multinational firm

is employed, the outcome is likely to be a limitation of analysis to those activities

that characterise the international bank rather than the multinational bank. The

distinction between international bank and multinational bank is an important

one, as many international banking operations can be provided without a bank

achieving multinational status. Activities that are international, but not

necessarily multinational, include trading in foreign currencies, the provision

1 As an example, foreign banks can lend to U.S. customers from overseas locations and entirelyescape U.S. regulation (Baer, 1990).2 See, for example, Lewis and Davis (1987), page 221.3 As an example; Kindleberger (1969).4 Aharoni (1971) has offered additional approaches toward multinationality. These are thestructural approach, the performance criteria method and the behavioural approach. Under thestructural approach, firms are considered multinational if they organise the firm on the basis ofcountries or regions. Under the performance criteria approach, firms are multinational if theymeet some measure of multinationality. The behavioural approach classifies firms as multina-tional if they think internationally. Various problems and advantages accompany each of thesefour approaches.

The Defensive Expansion Approach to Multinational Banking 129

of trade finance and ownership of securities issued by foreign firms. Thus

reference to the appropriate definition of the multinational firm is an important

first step in correctly classifying banks as multinational versus international.

There are three economic functions of multinational banks (Davis and Lewis,

1982). First, multinational banks mismatch assets and liabilities across curren-

cies. The currency preferences of borrowers are not necessarily identical to those

of savers, and multinational banks resolve these preferences. Second, multina-

tional banks transform preferences across borders. The final function is that of

transforming the maturity of deposits into the preferred maturity of borrowers.

This is a core function of banks, and of most financial institutions. The role of

multinational banks in this context has been the subject of some examination;5

however, that issue will not be explored in this paper. It should be noted that

some multinational banks do not provide all of these services. Some multina-

tional banks will restrict their Eurobanking to a single currency, and so will not

offer the first of these economic functions. Other multinational banks will

confine their activities to providing intermediation in each host nation, without

actively transferring funds between their different national locations, and so will

not provide the second of these services. In some cases multinational banks will

confine their operations to the third of these functions, maturity transformation.

The theory of the multinational enterprise and the related theories of

multinational banking have evolved to explain why multinational banks offer

these transactions services via a direct presence rather than by using the open

market.6 Such theories also provide insights as to why some multinational banks

do not provide all of the functions listed above.

III. DEFENSIVE EXPANSION

Development of Defensive Expansion Theory

The following client phenomenon has occurred over a prolonged period.

Brimmer and Dahl (1975) first integrated defensive expansion into the

contemporary multinational banking literature. This application was initially

the discussion of the impact of specific regulations upon the incentive for U.S.

banks to expand offshore. Brimmer and Dahl (1975) argued that the restrictions

imposed by the Interest Equalisation Tax (IET) and the Voluntary Foreign

Credit Restraint Program (VFCRP) hampered the ability of U.S. banks to fulfil

the offshore requirements of existing clients, particularly those with subsidiaries

overseas. By expanding to overseas locations, particularly London, and

providing offshore facilities via the Euromarkets, the impact of the IET and

VFCRP could be mitigated.7 Grubel (1989) later argued that escape from

5 See for example, Hewson (1975), Niehans and Hewson (1976).6 Williams (1997) provides a detailed discussion of the relationship between the theories of themultinational enterprise and theories of multinational banking.7 See also Terrell, Dohner and Lowrey (1990).

130 Barry Williams

regulation imposed externalities that were also relevant for multinational

banking in the context of tax evasion and reserve requirements. Brimmer and

Dahl (1975) argued that the banks were acting to internalise, in a Coasian sense,

their existing bank–client relationship before this relationship was taken over by

a bank not restricted by the IET and VFCRP.

Fieleke (1977) and Grubel (1977) expanded the initial regulatory focus of

Brimmer and Dahl (1975) to a more general principle. The knowledge that a

bank gains during the bank–client relationship is not cost free. However, when

the client expands offshore this existing knowledge can be applied to the

client’s offshore operations at low marginal cost (Grubel, 1989).8 These lower

marginal costs are the result of economies of scope (Rugman and Verbeke,

1993). As argued by Rugman and Verbeke (1993), economies of scope are

more important than economies of scale for multinational banks as economies

of scope are more attainable. Additionally, the long-term bank–client

relationship has value for the bank. As a consequence, the bank will adapt

its location mix of branches, both domestically and internationally, in order to

ensure that the bank-client relationship is kept intact. The bank–client

relationship is a component of a bank’s franchise value (Demsetz et al.

1996), and as such banks are willing to alter the nature of their operations to

retain this franchise value.

The Central Role of Information Flows

Ownership of the information flows embodied in the bank–client relationship is

the main asset of a bank (Llewellyn, 1996). The knowledge capital embodied in

this franchise value is difficult to sell in the market. As a result, the bank cannot

elect to service its existing clients overseas by exporting information to banks in

the host nations. This client knowledge has been termed commercial intelligence

(Gray and Gray, 1981; Miller and Parkhe, 1998). This term provides increased

insight into the lack of an external market for this information. This lack of an

external market is due to the market for client information failing to reach an

equilibrium price. There are two components to this failure to achieve a market-

clearing price for the bank’s client-specific knowledge capital. The first is that the

existence of information asymmetry results in the bank being unable to achieve

what it considers a fair price for client specific information (Grubel, 1977). The

second is that the sale of client-specific information to another bank is likely to

result in the new bank pre-empting the existing bank–client relationship. It is

this fear of losing existing bank–client relationship to a competitor bank that

results in banks accompanying their clients abroad. As argued by Kindleberger

(1983), defensive expansion is not necessarily aimed at generating profits in the

new region, but is instead aimed at preventing losses at a pre-existing location.

8 This lower marginal cost particularly relates to evaluation of loan proposals. Grubel (1989)argued that this motivation was particularly important for multinational service banking.


However, Caves (1977) considered the banks’ clients will also face transactions

costs when changing banks. Thus, it is not completely clear that banks will

always accompany their clients abroad, as there are alternative mechanisms to

provide banking services across borders. These alternative mechanisms, such as

correspondent banking and representative offices, do not always imply a

transaction-based presence.

The central role of information in the defensive expansion hypothesis is

consistent with both the eclectic and internalisation approaches to the

multinational enterprise.9 Khoury (1979) argued that the bank’s willingness to

adjust its location strategies in response to client behaviour implies an internal

market for client information. The internalisation of information was considered

by Rugman (1981) to be the principal advantage of the multinational bank. This

information becomes, within the firm, a public good, best exploited via foreign

direct investment (Buckley and Casson, 1991). Casson (1990) highlighted the

role of personal contact in multinational banking. There are limited opportu-

nities for creation of monopolies in multinational banking as the products do

not lend themselves to protection via patents (Dufey and Giddy, 1981), and

expertise can be hired away from innovating banks by paying the appropriate

wage (Merrett, 1990). In this context, personal contact via a network of

branches collecting and processing information, and an established infrastruc-

ture of skills, becomes a key asset specific to the multinational bank.

Internalisation gives a central role to market failure, particularly in intermediate

products (Casson, 1995). Information is a key intermediate product for

multinational banking. Information is also a product for which it is difficult

to develop a well-functioning market. As a result, banking is an industry in

which transactions cost reduction via internalisation of intermediate products is

a natural outcome. Thus, any bank wishing to exploit its comparative

advantages globally will expand via internalisation rather than trading its key

products. The result is the development of multinational banking rather than a

market for client information. Barron and Valev (2000) illustrated the

importance of information in international banking by U.S. banks. It was

argued that larger (wealthier) banks have advantages in the purchase of

information, which is central to the decision to invest offshore.10 Within the

context of defensive expansion theory, the argument of Barron and Valev (2000)

translates into the contention that larger banks (with larger client bases) will be

more able to exploit that advantage generated by their knowledge base and so

expand offshore. A later section will discuss the empirical implications of this

issue.

9 The role of these two paradigms within the context of multinational banking is discussed inWilliams (1997).10 Barron and Valev (2000) used Granger causality to find that smaller banks tend to follow theinternational banking activity of larger banks.

132 Barry Williams

The rise of listed rather than family-owned firms accentuated the need for

information collection and collation networks, due to increased demands for

delegated monitoring of large projects. The increased size of projects that

accompanied the rise of the listed firm resulted in an increased need to monitor

debt-funded non-banks. As debt funded non-banks moved abroad, so the need

for co-located monitoring also increased. This need is best met by establishing a

physical presence close to the client. Via co-located monitoring, the multina-

tional bank is both protecting (internalising) its bank-client relationship, while

also protecting its interests as the provider of debt funds to large clients.

Information and monitoring costs are significant reasons for many multina-

tional corporations, including multinational banks, to choose direct investment

rather than licensed production (Ruffin and Rassekh, 1986). The central role of

information flows in defensive expansion theory means that it is best considered

within the structure offered by internalisation theory. In industries where

information is a key intermediate product, the incentives to develop an internal

market are the greatest (Williams, 1997). This internal market can be best

exploited via foreign direct investment, thus resulting in multinationality

(Buckley and Casson, 1991). As discussed below, multinationality of banking

does not necessarily arise as a result of expansion from domestic base. Thus

internalisation theory provides an internally consistent structure within which to

discuss empirically testable theories such as the defensive expansion hypothesis

(Williams, 1997).

Defensive Expansion: A Historical Perspective

Economic historians such as Jones (1993a and 1993b) observed that British

multinational banking in the nineteenth century followed the pattern of British

imperial expansion. The transactions costs of using existing markets to serve

the needs of multinational clients were observed to be high relative to the

transactions costs of establishing British-style banks in the host nation. Jones

(1993a and b) also observed that the pattern of nineteenth century multinational

banking differed from that observed post-World War Two. In the first phase of

true multinational banking, the nineteenth century, the British multinational

banks were formed exclusively to provide banking services outside Britain, with

no equity links to domestic British banks, and no domestic banking business.

These multinational banks were also observed by Jones (1993 a and b) to behave

somewhat differently to the modern multinational bank, in that they were

characterised by geographical specialisation rather than geographical diversifi-

cation. As stated by Jones (1993a, p. 32) ‘‘Finance of international trade was the

core business of overseas banks.’’ These activities were strongly, but not

completely, linked to British overseas investment. As pointed out by Jones

(1993b), international banking has a long history, but multinational banking, in

a form that is recognisably within the spirit of the previous section, is a relatively

modern phenomenon.


The second recognisable phase of multinational banking was post-World War

Two, which saw a relative decline of British multinational banks and the rise

of U.S. multinational banks.11 Jones (1993b) argued that it was the trade focus

of the British banks that made it difficult for them to cope with the new world of

multinational banking that arose in the 1960s. Jones (1993a) argued that a lack

of flexibility by the British banks and reduced receptiveness of the host nations

contributed to this decline.12 Post-World War Two multinational banking was

initially dominated by the expansion of domestic U.S. banks into multination-

ality. This was a different pattern of multinationality than observed for the

British banks. As observed by Jones and Wale (1998), British MNCs of the pre-

World War Two era were usually established to undertake offshore investment,

in contrast to U.S. MNCs of the same era, which usually grew out of established

domestic companies. The initial dominance of post-World War Two multina-

tional banking by the U.S. banks is also reflected in the state of the literature to

date. Many of the studies to date have a focus upon the expansion of U.S. banks

offshore, or upon foreign banks expanding into the United States.13 It is this

U.S. focus that has resulted in Grubel (1989) arguing that once a bank has

expanded to the fullest possible domestic extent, it then must expand overseas.

Overseas expansion maximises the returns from those assets that cannot be

sold due to market failure, such as information about a particular client. As

discussed in Williams (1997), this approach toward multinational banking owes

its origins to eclectic theory (Dunning, 1973, 1977). However, as illustrated by

the above discussion, multinational banks can exist without a domestic base,

thus the theoretical underpinning of multinational banking is most appropri-

ately drawn from internalisation theory (Buckley and Casson, 1991; Williams,

1997). Internalisation theory provides a general theory of the multinational

enterprise. Specific theories such as defensive expansion provide the bridges

between the general theory and the observed empirical relationships. The

multinational is a mechanism via which transactions costs (in a Coasian sense)

are internalised, and defensive expansion theory provides an empirically testable

hypothesis that is consistent with the general framework.

While sharing some elements with eclectic theory, Berger et al. (2000) have

also provided a framework that allows defensive expansion theory to be placed

within a wider context. Berger et al. (2000) developed two hypotheses, the home

field advantage and the global advantage hypothesis. These hypotheses were

developed within the specific context of observed differences in efficiency

between domestic and foreign banks. The home field advantage hypothesis

argues that the foreign banks face various disadvantages when entering a new

11 As noted by Cho et al. (1987), the following clients effect was particularly apparent in thisera, especially post-1971 for foreign banks in the U.S.12 This reduced receptiveness can be particularly linked to the decline of the British Empire.13 This paper will demonstrate that there are more non-U.S. studies than the single study listedby Molyneux and Seth (1998). See Tables 1 and 2, this paper identifies a total of 22 papers thatconsider multinational banking from a non-U.S. perspective.

134 Barry Williams

market, and that these disadvantages explain why foreign banks are observed to

be less efficient than domestic banks. This approach has common ground with

the claim of eclectic theory that multinational banks need to own a market

advantage in order to compete with incumbent firms which possess a home field

advantage (Williams, 1997, p. 81). Hymer (1976) first proposed this argument in

1960, and Kindleberger (1969) adopted the theme that foreignness is a liability.14

Within the framework proposed by Berger et al. (2000) the home field advantage

hypothesis provides an explanation for the observed superior efficiency of

domestic banks over their foreign competitors.15 The alternative hypothesis to

the home field advantage is the global advantage hypothesis. The global

advantage hypothesis has two facets, the general form and the limited form.

Under the general form, efficient multinational banks are able to overcome the

incumbent advantages of domestic banks. The limited form of the global

advantage hypothesis argues that only those multinational banks with a firm-

specific or nation-specific advantage are able to overcome the incumbency of

domestic banks. One example of a firm or nation specific advantage is the bank’s

existing client base. Thus the defensive expansion hypothesis provides a

theoretical example of a limited global advantage. As argued above, such an

argument should be positioned within the context of internalisation theory. As

such, ownership of an asset that gives rise to the limited form of the global

advantage hypothesis would be due to market failure resulting in the owning

bank being unable to sell this asset (or only the offshore aspects of the asset). As

a result the bank chooses to exploit the benefits that arise from this asset by

multinational expansion.

Time Series Issues in Defensive Expansion

As argued by Fieleke (1977), following clients abroad may in fact establish a

beachhead from which the multinational banks expand to compete with the

incumbent bank in providing banking services to host nation non-banks. The

beachhead argument instils the defensive expansion hypothesis with a potentially

valuable dynamic as well as a static application. Seth and Quijano (1993) argued

that the beachhead approach explained the behaviour of Japanese banks in the

United States, although an empirical model was not estimated. Terrell (1993)

drew similar conclusions for foreign banks of all nationalities in the United

14 Tschoegl (2000) also discusses the liability of foreignness for a multinational bank, within thecontext of the modern features of cross border transactions. Tschoegl states that some banks donot actively seek to overcome this liability and are instead content to confine their dealings inthe host nation to home nation clients.15 Berger et al. (2000) find results that reject the home field advantage and support the limitedform of the global advantage hypothesis. The study found that when nationality of origin iscontrolled for, U.S. banks in a foreign nation are often more efficient than the domestic banks.Using a different approach Leveen and Praveen (1994) also found that performance of foreignbanks in the U.S. (as measured by financial ratios) is related to the structure of the parent bank.


States. Damanapour (1991) suggested that the beachhead approach to defensive

expansion is particularly important for smaller banks. The relationship between

firm size and defensive expansion has neither been considered empirically, nor

received substantial attention in the subsequent literature.16 The beachhead

argument provides a dynamic perspective to the defensive expansion hypothesis.

This dynamic perspective has, to date, received limited attention in the literature,

with the majority of the literature emphasising a static perspective.

Sabi (1995) explored the dynamic versus static issue. As Sabi (1995) observed,

correlation between multinational banking and trade and investment flows can

have four explanations. The first explanation is that the presence of multina-

tional corporations (MNCs) causes the entry of multinational banks (MNBs),

consistent with the defensive expansion arguments. The second explanation is

consistent with Kindleberger (1983), who argued that the presence of MNBs

causes the entry of MNCs. The third explanation is that MNB and MNC

activities are causally independent. The fourth explanation is that there is a

mutual causation between MNCs and MNBs and it is not possible to determine

the sequence of causation. To date it has not been entirely possible to distinguish

between the alternative explanations of the observed correlation between various

measures of multinational banking and defensive expansion proxies.17

Criticisms of Defensive Expansion Theory

The argument that banks follow clients abroad has been criticised by Aliber

(1984). As discussed by Sabi (1995),18 there is likely to be mutual causation

between MNCs and MNBs. Following the arguments presented earlier in this

paper, multinational banks can be considered as an industry-specific example of

multinational corporations. As argued by Aliber (1984), the factors that resulted

in multinational corporations from one country expanding into the host nation

may also explain why multinational banks from the same nation expand into the

same host nation. Thus, an omitted explanatory variable may provide an

explanation for the observation of defensive expansion behaviour by multina-

tional banks. Such possibilities include home market regulation, market growth,

and host receptiveness.

Defensive expansion theory does have flaws in that it does not analyse the

costs of international expansion. The role capital plays in international

16 Seth et al. (1998) and Molyneux and Seth (1998) included in their model a series of dummyvariables representing foreign bank size, and a number of studies have included a foreign banksize measure (Tschoegl, 1983; Giddy, 1983; Ursacki and Vertinsky, 1992). However, theinteraction between foreign bank size (in either the host or home markets) and defensiveexpansion measures have not been considered. The recent paper by Barron and Valev (2000)also demonstrates the importance of size in cross border expansion by banks.17 As will be discussed later in this paper, this issue has been addressed by Thornton (1992),Sabi (1995), Williams (1998a & 1998b) and Seth et al. (1998).18 Buch (2000) also considered this issue and stated that FDI measures may be endogenousrather than exogenous to multinational bank activity.

136 Barry Williams

expansion is also not considered. International expansion should only be

undertaken when the expected marginal cost of expansion does not exceed the

expected marginal gain. This theory can be regarded as a specific application of

the general theory of internalisation. In this case, the bank is investing offshore

to internalise its existing contractual and information relationships. Defensive

expansion is at best a partial explanation of why banks become multinationals,

with its emphasis upon the location decision of multinationality. However, other

special theories need to be employed to explain issues such as cost of capital and

why one bank from a nation will become multinational, while another will not.

As argued by Williams (1997), such theories should be drawn from a market

failure perspective, with an emphasis upon Coasian transactions costs.19

IV. EMPIRICAL APPLICATION OF DEFENSIVE EXPANSION THEORY

Following Trade or Investment?

While defensive expansion theory argues that banks follow their clients offshore,

it does not clarify which aspect of the client’s activities result in multinational

banking. The result has been that a number of empirical proxies for offshore

expansion have been applied when testing the defensive expansion hypothesis.

The alternative proxies can be classified into two general groups; (i) those that

consider direct investment from the home nation to the host nation; and (ii)

those that consider trading relationships. Table 1 details those studies that have

used investment measures when studying defensive expansion, while Table 2

details those studies that have employed trade measures. Those using direct

investment measures are assuming that direct investment in the host country

leads to a physical presence.20 That physical presence then leads to a demand for

a banking relationship that must be fulfilled by either the existing banking

relationship, or replaced by a bank already operating in the host country. Grosse

and Goldberg (1991) argued that following their client’s trade-related activities

has a similar motivation to following the investment activities, but that this

motivation can relate to different client groups. In a descriptive article,

Zimmerman (1989) was not able to distinguish between trade and direct

investment as motivating factors for Japanese bank growth in California.21

Walter and Gray (1983) argued that the restrictiveness of a country toward

19 Examples of such theories include the regulatory impact hypothesis (Klopstock, 1973; Ber-nal, 1982), the home market sophistication hypothesis (Grosse and Goldberg, 1991), the hostsize hypothesis (Nigh et al., 1986) and parent size or capital base hypothesis (Hirtle, 1991).20 This may not be true in all cases if the direct investment measure used includes portfolioinvestment by investment fund managers. Ideally the investment measure should exclude bankinvestment in order to remove potential endogeniety biases.21 Other descriptive studies supporting the defensive expansion hypothesis include Aguilar(1995), Goldberg (1992), Key and Welsh (1988), Khoury (1997) and Khoury and Pal (2000).Other papers that consider defensive expansion to be a partial explanation for multinationalbanking include Seth (1994) and Hasegawa (1993).


Table

1:EmpiricalTests

oftheDefensiveExpansionHypothesis

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

Fieleke

(1977)

U.S.banksoperating

overseas.Considered

aggregate

data

across

tencountriesin

1974

andacross

8countries

in1975

(1)Branch

totalassets

(2)Branch

activity

withforeign

non-banks

(3)Branch

net

income

U.S.Direct

investm

ent

position

OLSregressions

foreach

year

Proxypositive

andsignificantin

allcases.N¼

10

or8

Deanand

Giddy(1981)

U.S.banksin

Canada,

1972:4

to1981:1,

Canadianbanksin

the

U.S.,1974:2

to1980:1.

Quarterly

data,in

aggregate

(1)Foreignbank

assetsdivided

by

domesticbank

assets

(2)Foreignbank

commercialand

industrialloans

divided

bydomestic

bankcommercial

andindustrialloans

Totaldirectinward

investm

entdivided

byGNP

Tim

eseries

regressions

ForUSbanksin

Canadaproxy

negativeand

significant55

ForCanadian

banksin

theU.S.

proxyispositive

butnotsignificant

Goldbergand

Saunders

(1981a)

Aggregate

foreign

banksin

theU.S.,

quarterly

data,1972:4

to1979:2

(1)Number

of

foreignbankoffices

(2)Foreignsubsidiaries

share

oftotalbank

assets

Net

foreigndirect

investm

entinto

theU.S.

OLStimeseries

regressions

Proxypositivein

all

cases

Proxysignificantfor

variables1,2,and3

138 Barry Williams

(3)Foreignnon-sub-

sidiaries

share

of

totalbankassets

(4)Foreignshare

of

commercialand

industrialloans

Cho(1985)56

U.S.banksin

South

KoreaandSingapore,

1973–1980.Bankby

bank,annualdata

(1)Assetsin

host

countrymeasured

asashare

oftotal

host

commercial

bankdeposits

(2)Foreignbranch

Lendingasashare

oftotalhost

com-

mercialbank

lending

(3)Foreignbranch

deposits

asashare

ofhost

commercial

bankdeposits

(4)Foreignbranch

return

onassets

U.S.foreigndirect

investm

entto

host

countrydivided

by

host

GNP

(1)Individual

yearcross-

section

regressions,

includingboth

countries

(2)Pooled

regressions

across

banks

andtimefor

each

country

Sizeofhost

banking

market,amountof

foreigntradeand

defensiveexpansion

proxyare

allhighly

correlated,so

only

usedhost

banking

market

proxy.This

proxyispositive

andsignificantin

somecases

Jain

(1986)

Aggregate

data

ona

cross

sectionof46

developingcountries

and7Eastern

Europeancountries

Square

rootofU.S.

banksshare

ofloans

tothecountry57

Square

rootof

U.S.share

of

investm

entto

the

host

country58

OLSregression,

withinfluential

variables

identified.

Separate

Only

1982resultsrepor

ted.Proxypositive

andsignificant

forallcountries.

Significance


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

inwhichU.S.banks

hadassetsbetween

1977and1982

regressionsfor

each

year

removed

when

influentialvariables

omitted.Tradeand

investm

ent

measurescollinear

Nigh,

Cho,and

Krishnan

(1986)

U.S.bankoperations

in30countries,

1976–1982.

Aggregate

annual

data

Changein

U.S.

branch

assets

per

yearin

USD

millions

Changein

USdirect

investm

entin

host

countryin

USD

millions

Pooledtime

series

cross

section

regressions:

(1)OLS

(2)Pooledleast

squaresdummy

variable

estimation

(3)Poolederror

components

model59

Proxypositiveand

significantin

all

cases

Sabi

(1988)

U.S.banksin

23Less

Developed

Countries,

1975–1982.Aggregate

annualdata

U.S.branch

assetsin

host

country

U.S.Direct

investm

entin

host

country,book

value

Pooled

Regressions

(1)OLS

Proxypositiveand

significantin

all

cases

140 Barry Williams

(2)Least

squares

dummy

variables

(3)Variance

components

Goldberg,

Helsley

andLevi

(1989a)

Foreignbanksin

the

U.S.in

1984,state

level

data

(31states)

(1)Foreignbank

assets

(2)Foreignbanks

deposits

Number

ofForeign

corporations

headquartered

ineach

state

OLS

Proxypositiveand

significant,shows

someevidence

of

collinearity

with

number

of

corporationsin

each

state

Hultman

andMcG

ee(1989)

Aggregate

foreign

bankingin

theU.S.,

1973to

1986.Annual

data

(1)Share

ofU.S.

banksubsidiary

assetsheldby

foreignbanks

(2)Share

ofU.S.

branch

and

subsidiary

assets

heldbyforeign

branches

and

subsidiaries

Annualchangein

foreigndirect

investm

entinto

the

U.S.,excludingthe

finance,insurance,

andrealestate

industries,in

USD

billion

OLStimeseries

regressions

Proxypositiveand

significantin

all

cases


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

Hultman

andMcG

ee(1990)

Japanesebanksin

the

U.S.,1974to

1988.

Annualdata

Japaneseshare

ofU.S.

bankingassets

Annualchangein

JapaneseFDI

into

theU.S.

OLStimeseries

regressions

Proxypositiveand

significant

Goldberg

andJohnson

(1990)

U.S.banksin

22

countries,1972–1985

Aggregate

annual

data

(1)Assetsofforeign

branches

(2)Number

of

foreignbranches

U.S.direct

investm

entinto

host

country

Pooled

regressions,

N¼

240

Proxypositiveand

significantfor

assets.Proxy

negativeand

significantfor

number

of

branches

60

Budzeika

(1991)

Foreignbanksin

the

U.S.,annualand

quarterly

data,

1974:4

to1989:4,

aggregate

data

(1)Totalassetsof

foreignbranches

andagencies

(2)Commercialloans

offoreignbranches,

agencies

and

international

banking

facilities

(IBFs)

FDIinto

the

US

Forw

ard

stepwise

regressions.All

variablesin

first

differencesof

logarithms.

N¼

17(annual

data)or68,

quarterly

data)

(1)Nosignificant

contribution,

coeffi

cient

negative

(2)Nosignificant

contribution,

coeffi

cient

positive

142 Barry Williams

(3)Totalassets

offoreignbranches,

agencies

andIB

Fs

(4)Totalassetsof

foreignsubsidiaries

(3)Nosignificant

contribution,

coeffi

cientnegative

(4)Nosignificant

contribution,

coeffi

cient

negative

Grosseand

Goldberg

(1991)

Foreignbanksin

the

U.S.,1980–1988,by

country,aggregate

annualdata

(1)Foreignbank

assetsbycountry

(2)Number

of

foreign

bankoffices

Foreigndirect

investm

entand

foreignportfolio

investm

entin

the

U.S.,bycountry

oforigin

Pooled

regressions6

1Proxypositiveand

significantat1%

level

forboth

dependent

variables

Thornton

(1992)

Japanesebanksin

the

U.K

.,1975:1

to1989:1,quarterly

aggregate

data

Japanesebankassets

inLondonin

USD

divided

bynominal

JapaneseGDPin

USD

Totalworldwide

Japaneseforeign

directinvestm

ent

divided

bynominal

JapaneseGDPin

USD

Autoregressive

distributedlag

model,upto

6lags

Sum

ofcoeffi

cients

onthelags

employed

positive

andsignificant.

Lags1,2and4

employed

Wright(1993)Foreignowned

licensed

banksin

Australia,

1985–1992,eighteen

foreignbanks.Annual

bankbybankdata

Logofassetsin

Australia62

Volumeofnon-

officialcapitalon

Balance

of

Payments,across

all

countries,including

both

portfolioand

directinvestm

ent

Tim

eseries

OLS

regressions,one

foreach

bank

Proxypositiveand

significanttw

iceout

of18regressions,

once

at5%

level

andonce

at10%

level


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

Goldberg

andGrosse

(1994)

ForeignBanksin

the

U.S.;state

bystate

data.Annualdata,

1981–1989

(1)Totalassets

(2)Totaloffices

(3)Assetsofagencies

(4)Number

ofagencies

(5)Assetsofbranches

(6)Number

of

branches

(7)Assetsof

subsidiaries

(8)Number

of

subsidiaries

FDIinto

thestate

divided

bystate

income

Poolederror

components

model

andOLS,

OLSresultssame

aspooled;only

OLSshown

(1)Positiveand

significant

(2)Positive,

not

significant

(3)Negativeandnot

significant

(4)Negativeandnot

significant

(5)Positiveand

significant

(6)Positiveandnot

significant

(7)Positiveandnot

significant

(8)Positiveandnot

significant

Overall:

Defensive

expansiononly

holdsforassets

ofbranches

144 Barry Williams

Marashdeh

(1994)

Foreignbanksin

Malaysia,1980–1990,

across

11countries,

aggregate

annual

data

foreach

country

(1)Number

of

branches

andoffices

from

each

country

(2)Officesfrom

each

country

Homecountry

investm

entin

Malaysia,in

ringgits

Pooled

regression,

fixed

effects

model

Proxynegative.

Significantat5%

level

intw

ocases

outoffour6

3

Wrightand

Liesch(1994)

Foreignbanksand

foreignmerchant

banksin

Australia

1988to

1992.Annual

bankdata;pooled

Logoftotalassets

FDIfrom

home

countryinto

Australiabyyear

Pooleddata

estimatedusing

OLS

Proxypositiveand

significant

Sabi(1995)

Foreignbanksin

the

U.S.Quarterly

aggregate

data

1980:2

to1993:4

Assetsofbranches

andagencies

ForeignDirect

Investm

entinto

theU.S

Granger

Causality

Thepresence

of

foreignbanks

Granger

causes

FDI,butFDIdoes

notGranger

cause

oreignbanking

Waheed

andMathur

(1995)

AnnouncementofU.S.

banks’offshore

expansioninto

theith

nation,1963to

1989

Eventstudy

methodology

Standardised

cumulativeaverage

residual(SCAR),tw

odaywindow

()1,0):

(1)Allevents,(N¼

141)

(2)Rep.office

events,

(N¼

26)

(3)Branch

events,

(N¼

60)

FDIbyU.S.firm

sinto

theithhost

nation

OLSregression,

usingaverage

residualsfrom

eventstudyas

dependent

variable

(1)Negativeand

significant

(2)Notestimated:

insufficient

observations,

somedata

not

available

(3)Somedata

not

available,N¼

34,

variable

not


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

(4)Jointventure

events,

(N¼

27)

(5)Subsidiary

events,

(N¼

27)

(6)Acquisitionevents,

(N¼

41)

significant,model

notsignificant

(4)Notestimated:

insufficient

observations,

somedata

not

available

(5)Negativeandnot

significant

(6)Negativeand

significant

Wengel

(1995)

Foreignbanksin

141

countries,listed

inthe

Banker’sAlm

anac

(1990)

(1)Number

of

branches

(2)Number

of

subsidiaries

(3)Number

of

representative

offices

AssetsofMNCsin

host

country64

Logit

regressions

Proxypositiveand

significantin

all

cases

Brealey

andKaplanis

(1996)

1000largest

banksin

1992

Logofnumber

of

banksfrom

country

iin

host

nationj

(a)FDIfrom

parent

countryi

tohost

j

(1)OLSwith

Whites

correction

applied

to

(1)Positiveand

significantfor

both

(a)and(b)

Outw

ard

FDI,

146 Barry Williams

(b)FDIfrom

host

jto

parent

countryi

pooleddata.

Separate

regressionfor

each

trade

variable

(2)OLSfor

selected

individual

nations,

(A)Parent

nation

regressions

and

(B)Host

nation

regressions

variable

(b),while

significant,had

limited

economic

value

(2)Inward

FDIonly

used

(2A)11of12

coeffi

cients

positive,

6significant

at95%

level.On

average

explanatory

power

increasedby

6%

due

toFDI

variable

(2B)3of7

coeffi

cients

negative

(UK

significant,

indicates

substitution

effect),

average

coeffi

cient


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

close

tozero,no

increase

inexplanatory

power

on

average

Fisher

and

Molyneux

(1996)

Foreignbanksin

London,1980to

1989.

Annualaggregate

data

(1)Number

ofbanks

(2)Number

ofstaff

(3)Number

ofbanks

from

Europe

(4)Number

ofbanks,

excludingUSA

and

Japan

(5)Number

ofstaff

from

Europe

6)Number

ofstaff,

excludingUSA

and

Japan

(a)FDIinto

theUK

(b)FDIout

ofUK

Pooleddata

with

missing

observations:

techniquenot

clear,could

be

OLS

(a)Negativeandnot

significantfor(1)

and(2)

(a)Positiveand

significantfor

(3),(4),(5)

and(6)

(b)Positiveandnot

significantfor

(1),positive

andsignificant

for(2).

(b)Negativeandnot

significantfor(3)

and(6),negative

andsignificantfor

(4)and(5)

148 Barry Williams

Hondroy-

iannisand

Papapetrou

(1996)

Foreignbanks

inGreece1981to

1992,annual

aggregate

data

(1)Totalassets

(2)Number

of

branches

FDIinto

Greece

Pooleddata,

model

estimated

witherror

correction

model

with

correctionfor

autocorrelation

Positivebutnot

significantforboth

(1)and(2),resultsnot

shown

Moshirian

andSim

(1996)

U.S.bank’s

1970–1992,annual

aggregate

data

U.S.banks’foreign

assets.Note:thisis

astudyof

internationalrather

thanmultinational

banking

Realstock

ofU.S.

ForeignDirect

Investm

entabroad

(a)Ordinary

Least

Squares,

(b)Instrumental

Variables,

(c)Generalised

Methodof

Moments

Negativeand

significantfor(c).

Negativeandnot

significantfor(a)

and(b)

Williams

(1996)

Japanesebanksin

Australia,1987–1992,

and1988–1992.

Annualbankdata

(1)Assetsin

$A

(2)Market

share

(3)Return

onassets

after

tax

(4)Return

onassets

before

tax

JapaneseFDIinto

Australiain

Australiandollars

Pooleddata,

Kmenta’s(1986)

method

Negativeand

significantfor(2).

Notsignificant

otherwise.

Evidence

ofcollinearity

Millerand

Parkhe

(1998)

U.S.banksin

32


(office

types);

1990–1995(assets).

Annualaggregate

data

Assets:

(1a)Alloffices

(1b)Branches

(1c)

Subsidiary

Number

ofOffices:

(2a)Alloffices

U.S.FDIinto

the

ithcountry

Pooleddata

estimatedwith

OLS,White’s

(1980)correc-

tionMissing

observations

(1)Positiveand

significantin

all

cases

(2)Positiveand

significantin

all

cases


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

(2b)Branches

(2c)

Subsidiary

(3)TotalAssets

(3a)Industrial

Countries

(3b)Developing

Countries

(4)Branch

Assets

(4a)Industrial

Countries

(4b)Developing

Countries

Subsidiary

Assets

(5a)Industrial

Countries

(5b)Developing

Countries

(6)Office

Numbers

(6a)Industrial

Countries

(6b)Developing

Countries

deleted,

(n¼

270

foroffices;

n¼

140for

assets)

(3)Positiveand

significantfor(3a),

positiveandnot

significantfor(3b)

(4)Positiveand

significantfor(4a),

positiveandnot

significantfor(4b)

(5)Positiveand

significantfor(5a),

negativeandnot

significantfor(5b)

(6)Positiveand

significantin

both

cases

150 Barry Williams

Millerand

Parkhe

(1998)

[cont’d]

U.S.banksin

32


(office

types);

1990–1995(assets).

Annualaggregate

data

(7)Branch

Offices

(7a)Industrial

Countries

(7b)Developing

Countries

(8)Subsidiary

Offices

(8a)Industrial

Countries

(8b)Developing

Countries

(9)Subsidiary

offices/

totaloffices

(9a)AllCountries

(9b)Industrial

Countries

(9c)

Developing

Countries

U.S.FDIinto

the

ithcountry

Pooleddata

estimatedwith

OLS,White’s

(1980)correc-

tion.Missing

observations

deleted,(n¼

270

foroffices;

n¼

140for

assets)

(7)Positiveand

significantin

both

cases

(8)Positiveand

significantin

both

cases

(9)Positiveand

significantfor(9a)

and(9b),positive

andnotsignificant

for(9c)

Molyneux,

Rem

olona

andSeth

(1998)

ForeignBanksfrom

14countriesin

the

U.S.Quarterly

bank

level

data,1990:1

to1992:3

(1)Profits:

(1a)Return

on

Assets;or

(1b)Return

onEquity

(2)Logofchangein

commercialand

industrialloans

FDIinto

theUS

from

theithbank’s

country

TwoStageLeast

Squares.Thetw

odependent

variableswere

modelled

simultaneously

FDIincluded

inthe

loangrowth

equation

only:Positiveandnot

significant

Molyneux

andSeth

(1998)

ForeignBanksin

the

U.S.from

14countries;

1987–1991;Annual

banklevel

data

(1)Profits:

(1a)Return

on

Assets;or

FDIinto

theUS

from

theithbank’s

country

TwoStageLeast

Squares

FDIincluded

inthe

loangrowth

equation

only:Positiveandnot

significant


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

(1b)Return

on

Equity

(2)Logofchangein

commercialand

industrialloans

Moshirian

(1998)

Foreignbankinvest-

mentin

Australia,

1985–1996,aggregate

quarterly

data:1994

to1996annualdata

usedto

construct

quarterly

data

Stock

ofFDIin

bankingin

Australia

measuredin

current

period’sUSdollars

Stock

ofFDIin

Australian

manufacturing

sectorin

current

period’sUSdollars

OLSwith

instrumental

variable

estimation

andGMM

tocontrolfor

heteroskedasticity

Positiveand

significant

Moshirian

andVander

Laan(1998)

ForeignassetsofU.S.,

U.K

.andGerman

banks1985(1)to

1995(4).Quarterly

aggregate

data

RealforeignAssetsin

U.S.dollars,note

thatthisisastudyof

internationalrather

thanmultinational

banking

Stock

ofnon-Bank

FDIabroadfrom

thehost

nation

(1)OLSwith

correctionsfor

heteroscedas-

ticity

(2)Generalised

Methodof

Moments.

Only

these

resultsshown

NonbankFDI

significantand

negative

152 Barry Williams

Country

specific

regressions

conducted

Williams

(1998a)

Foreignbanksin

Australia1987–1993.

Annualbankbybank

data

(1)Assetsin

Australiandollars

(2)Return

onAssets

after

tax

FDIflow

into

Australiafrom

the

ithbank’scountry

Cross

section

bounded

regressions,

yearbyyear

Notsignificantfor(1)

or(2)

Williams

(1998b)

Foreignbanksin

Australia1987–1993.

Annualbankbybank

data

(1)Assetsin

Australiandollars

(2)Return

onAssets

after

tax

(a)Currentvalueof

FDIflow

into

Australia

(b)Lagged

valueof

FDIflow

into

Australia

Unbalanced

pooled

regressions

(1)Notsignificantfor

(a),positiveand

significantfor(b)

(2)Positiveand

significant

(although

economically

small)for(a)not

significantfor(b)

Yamori

(1998)

Japanesebankoffshore

expansion,1951to

1994

(1)Logofaccumu-

latedstock

ofbank

FDIin

theithhost

nation,1951to

1994

(2)Logofaccumu-

latedstock

ofbank

FDIin

theithhost

nation,1990to

1994

(a)LogofJapanese

manufacturing

FDIinto

theith

country

(b)Logof(Japanese

manufacturing

FDIinto

theith

country+

Japaneseexports

OLS

(1a)Generally

positiveand

significant,not

significantifLog

ofM2included

inmodel

(1b)Positiveand

significant


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

into

theith

country)

(2a)Positiveand

significant;M2

notincluded

inresultsshown,(b)

notincluded

inresultsshown

Konopielko

(1999)

Foreignbanksin

Poland,Hungary

andtheCzech

Republic

(1)Survey

of70

banksin

Poland

Hungary

andCzech

Republic

in1996

(2)0ifbanksnot

present,1ifbank

present

Stock

ofFDIin

host

nation

(a)Logit

regressions

(b)OLS

(1)Survey:Following

clients

important

forPolandand

Czech

Republic,

butnotfor

Hungary

(2)Positiveand

significantfor

Poland,positive

andnotsignificant

forHungary

and

Czech

Republic

Moshirian

andPham

(1999)

Australianbank

offshore

expansion

1985to

1995.Quarterly

data

1985to

1993,

Stock

ofAustralian

FDIin

banking

abroad

Stock

ofAustralian

FDIin

manufacturing

abroad

Allstock

data

transform

edinto

flowsto

ensure

stationarily

Positiveand

significant

154 Barry Williams

annualdata

1994to

1995

Generalised

methodof

moments

estimation

applied

Buch

(2000)

Offshore

bankingby

Germanbanks1981

to1998.Annual

aggregate

data.Study

coversupto

37

countriesofoperation

byGermanbanks

(1)LogofFDIby

Banksin

1997

(n¼

20)

(2)Logof

foreignassetsof

domesticbanksin

1997[international

banking],(n¼

35)

(3)LogofAssetsof

foreignbranches

in997(n¼

38)

(4)Logofassetsof

foreignsubsidiaries

in1997(n¼

37)

(5)Changein

logof

foreignassetsof

domesticbanks

1982to

1998

[international

banking](n¼

462)

(a)LogofGerman

non-bankFDI

(b)Logoftotal

GermanFDI

(includingBank

FDI)

lagged

by

oneperiod

(c)Changein

log

oftotalGerman

FDI(including

BankFDI)

OLSwithWhites

correctionfor

cross

section

study.Panel

estimations

controllingfor

non-stationarity,

errorcorrection

model

forpanel

data,fixed

effects

estimation

(a)Positiveand

significantfor(1).

(b)Positiveand

significantfor(2),

(3)and(4).

(b)Positiveand

significantfor(6)

(c)Positiveand

significantfor(6)

FDIvariablesnot

tested

for(5)and(7)


Table

1:Continued

Author

Subject

Dependent

Variables

DefensiveExpansion

Proxy(Independent

Variable)

Estim

ation

Method

Result

(6)Changein

logof

assetsofforeign

branches

1981to

1997,(n¼

477)

(7)Changein

logof

assetsofforeign

subsidiaries

1987

to1998,(n¼

390)

Note

(1)to

(4)are

stock

variables,(5)

to(7)are

flow

variables

Note:Buch

alsoused

LogofFDIbybanks

aover

theperiod1981

to1997(?)asa

dependentvariable

inpanel

regression,with

logofnonbankFDI

asanindependent

variable.Theresults

ofthisregression

werenotshownin

the

paper.Buch

found

non-bankFDIto

be

negativeand

significant.(See

page

50)

Moshirian

(2001)

FDIin

bankingfrom

Germany,U.K

and

U.S.from

1983(1)

to1995(4).Quarterly

aggregate

data

Changein

logof

bankforeignassets

Changein

log

ofFDIin

non-financial

industries

GMM

estimation.

Separate

regressionsfor

each

nation

Non-bankFDI

positiveand

significantin

allcases

156 Barry Williams

55Thisresultwasnotexplained

ordiscussed

bytheauthors.

56Thisstudywaslaterpublished

inrefereed

journalsasCho(1986a)and(1986b).Theresultsofthesetw

ostudiesare

thesameas

Cho(1985)withCho(1986a)discussingthecross

sectionresultsandCho(1986b)discussingthepooledresults.

57Jain

usedthesquare

rootofthevariablesin

order

toinduce

theirnorm

ality.

58Jain

modelledadirectinvestm

entproxywithatradeproxy,butdid

notcontrolforthesimultaneity

problem

discussed

earlier,

asover

thesample

periodtradefinancingwasasm

allproportionoftotalbanklending.

59Thedifferentestimationmethodswereusedin

order

toestablish

therobustnessofthemodel

totheestimationmethod.The

model

tested

wasgenerallyconsistentin

itsresultto

theestimationmethod.

60GoldbergandJohnson(1990)argued

thatlarger

bankpremises

are

theresultofoutrightcompetitionwiththedomesticbanks.

TheresultisconsistentwiththebeachheadargumentofFieleke(1977).

61GrosseandGoldberg(1991)considered

thatasthetimeperiodofthestudywasshort,theuse

ofavariance

componentsmodel

wasnotnecessary.

62Thedependentvariable

islogged

inorder

toensure

itsnorm

aldistribution.

63Marashdeh

usedtestsfortheeff

ects

ofthepresence

ofJapaneseactivityuponthefirstdependentvariable,andtheeff

ects

of

Singapore

activityupontheseconddependentvariable.Theresultisconsidered

tobedueto

regulatory

restrictiononthemethods

offinancinginvestm

entin

Malaysia,andthatfew

banksin

thesample

werefrom

themajorsources

ofinvestm

entin

Malaysia.

64Thisvariable

appears

tohavebeenadded

tothetrademeasure.


foreign banks would be a reflection of its openness to foreign investment and

trade. Thus, countries that conduct vigorous international trade and investment

will be more receptive to the entrance of foreign banks. As a result, trade and

investment measures may be proxies for receptiveness rather than following

clients.

Performance Measures Employed in Defensive Expansion

In addition to the choice of independent variables used to measure defensive

expansion, there is also a range of possible choices to measure performance of

the multinational bank in the host market. The defensive expansion hypothesis

in its simplest form is specified as shown in equation 1, below:

Performance ¼ aþ bðdefensive expansion measureÞ ð1Þ

As discussed above, the expected value of b is positive. There has been a range of

performance measures applied in the studies detailed in Tables 1 and 2. These

measures can be classified into two groups; size measures (the most common);

or, profit measures. Size measures that have been applied to date include; assets

in the host nation (Cho, 1985), commercial loans in the host nation (Poulson,

1986), deposits in the host nation (Goldberg and Saunders, 1980), number of

offices in the host nation (Marashdeh, 1994), number of staff in the host nation

(Fisher and Molyneux, 1996) and market share in the host nation (Galiatsos and

Papapetrou, 1995). In some cases these measures have been divided into sub-

categories to measure whether the defensive expansion effect differed across

organisational types, such as agency, branch, subsidiary and representative office

(Goldberg and Saunders, 1981b; Heinkel and Levi, 1992; Buch, 2000).22 Those

studies employing count data as the dependent variable, such as staff numbers

and number of branches, generally employed Ordinary Least Squares regres-

sions to estimate the impact of defensive expansion. It would be worthwhile

considering employing empirical models designed for dependent variables of this

type, such as the Poisson regression model. As discussed by Greene (2000), it is

appropriate to use an estimation technique that explicitly accounts for this type

of dependent variable, particularly if the dependent variable has a large number

of zeros and small values.

The second type of performance measure used to determine the extent of

defensive expansion has been profit measures. This type of study is less common,

with the usual approach being to specify a model of factors that determine

multinational bank performance and then apply a profits measure as one of

22 For those studies using foreign investment as the defensive expansion measure, there was noconsistent pattern of the impact of organisational type upon defensive expansion. In the case ofthose studies using trade finance measures to consider defensive expansion, it seems thatagencies are more likely to be employed to follow trading activities of clients, (Goldberg andSaunders, 1981b). However, this cannot be considered a conclusive result.

158 Barry Williams

several alternative measures of multinational bank performance. In this

approach, the profit measures usually applied are either return on assets or

return on equity. Such an approach does not distinguish between factors that

determine profits and those that determine size, or consider that profits and size

are determined jointly. The studies by Molyneux et al. (1998) and Molyneux and

Seth (1998) have considered this simultaneity. However, the development of a

model specifically for multinational bank profits is an area that would benefit

from further research. The other approach to the profits issue in defensive

expansion was that of Waheed and Mathur (1995), who employed event-study

methodology. The evidence to date regarding the impact of following clients

upon multinational bank profits will be discussed in more detail in a later

section.23

Substitution between Multinational and International Banking

Moshirian and Sim (1996) considered the relationship between the offshore

assets of U.S. banks a trade variable and a direct investment measure. The

offshore assets measure used in this study reflected the provision of financial

services by U.S. banks to offshore customers. This is, in effect, international

banking rather than multinational banking. The provision of financial services,

(as opposed to multinational banking), does not require a physical presence

overseas.24 Moshirian and Sim (1996) found that U.S. exports were positively

and significantly related to international banking. However, direct investment

overseas was consistently found to have a negative and significant relationship

with the size of foreign assets held domestically. The authors argued that these

results represented a substitution between international banking (offshore

assets created from the home market) and multinational banking (offshore

assets created from offshore locations).25 Moshirian and Sim (1996) argued that

as U.S. FDI increases, U.S. bank behaviour changes from provision of

financial services via international banking from the home nation (servicing

23 Studies such as Berger et al. (2000) and Peek et al. (1999) have found that foreign banks in theU.S. are less profit efficient than domestic U.S. banks. However, these studies have not includeda defensive expansion measure.24 Other relevant papers that consider international banking but do not include a defensiveexpansion measure are Moshirian (1993, 1994a, 1994b and 1996).25 Moshirian (1998) and Moshirian and Pham (1999) found that international banking andmultinational banking are complements. These studies found domestic foreign currency assetsto be positively correlated with offshore investment by Australian banks. This is consistent withthe international experience arguments of Tschoegl (1982a). This is in contrast with Ruffin andRassekh (1986) who found foreign assets to be substitutes for FDI in banking. However, themeasure used by Moshirian (1998) and Moshirian and Pham (1999) for foreign assets includedboth international banking and multinational banking. Thus the dependent variable incorpo-rated activity potentially also included in the independent variable, producing a potential en-dogeniety bias. Moshirian (1998) attempted to address this problem by using instrumentalvariable estimation, however, these results should be treated with caution, as the criticism ofJain (1986, p. 74) is also relevant in this context.


Table

2.EmpiricalTests

oftheTradeFinance

Hypothesis.

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

Fieleke(1977)

U.S.banks

operatingoverseas.

Aggregate

data

across

ten

countriesin

1974

andacross

8countriesin

1975

(1)Branch

total

assets

(2)Branch

activitywith

foreign

non-banks

(3)Branch

net

income

Exportsplusim

ports

oftheUnited

States

OLSregressions

foreach

year

Tradeproxynegative

andsignificantfor

(1)and(2)for1974.

Tradeproxyhighly

correlatedwithhost

market

proxy.

N¼

10or8

Terrell(1979)

U.S.banksin

Japan

andJapanese

banksin

theU.S.,

1972to

1978,

monthly

aggregate

data

(1)Monthly

changein

loans

byJapanese

branches

of

U.S.banks

(2)Monthly

change

inloansbyU.S.

agencies

and

branches

of

Japanesebanks

(3)Monthly

change

inloansbyall

U.S.subsidiaries

ofJapanese

banks

Changein

Japanese

trade(exports

plusim

ports)

inU.S.D

.billion

OLSwith

Cochrane–Orcutt

Positivebutnot

significantfor(1),

positiveand

significantfor(2)

and(3)

160 Barry Williams

Goldberg

andSaunders

(1980)

U.S.banksin

the

United

Kingdom,

quarterly

aggregate

data,1961:1

to1978:2

TotalU.S.bank

deposits

inthe

U.K

.,in

all

currencies,

measuredin

U.S.D

millions

U.S.exportsto

theU.K

.,in

U.S.D

.millions

OLSestimation,

withCochrane–

Orcutt

Tradeproxypositive

andsignificant

Deanand

Giddy(1981)

U.S.banksin

Canada,1974:4

to1981:1,Canadian

banksin

theU.S.,

1974:2

to1980:1.

Quarterly

aggregate

data

(1)Foreignbank

assetsdivided

bydomestic

bankassets

(2)Foreignshare

of

commercialand

industrialloans

Exportsplus

importsdivided

by

host

G.N

.P.

Tim

eseries

regressions

Tradeproxypositive

andsignificantin

all

cases

Goldbergand

Saunders

(1981a)

Foreignbanks

intheU.S.,

1972:4

to1979:2,

quarterly

aggregate

data

(1)Number

of

foreignbank

offices

(2)Foreign

subsidiaries

share

oftotal

bankassets

(3)Foreignnon-

subsidiaries

share

oftotal

bankassets

(4)Foreignshare

of

commercialand

industrialloans

U.S.exportsdivided

byU.S.personal

income

OLStimeseries

regressions

Proxynotsignificant


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

Goldbergand

Saunders

(1981b)

Foreignbanksin

theU.S.quarterly

aggregate

data,

1972:4

to1980:1

Totalassetsof:

(1)Foreign

agencies

(2)Foreign

branches

(3)Foreign

subsidiaries

U.S.im

ports

divided

byU.S.

GNP65

GLSestimation.

TheGLS

estimationwas

apparentlyto

controlforthe

presence

of

autocorrelation

However

thiswas

notcompletely

discussed

Tradeproxypositive

andsignificantfor

(1),butnotfor(2)

or(3)66

Cho(1985)

U.S.banksin

South

Koreaand

Singapore,1973–

1980.Bankby

bankannual

data

(1)Assetsin

host

country

measuredasa

share

oftotal

host

commercial

bankdeposits

(2)Foreignbranch

lendingasashare

oftotalhost

commercialbank

lending

(3)Foreignbranch

deposits

asa

Host

exportsand

importswiththe

U.S.divided

by

host

GDP

(1)Individual

year

cross–section

regressions,

includingboth

countries

(2)Pooled

regressions

across

banksand

timeforeach

country

Sizeofhost

banking

market,tradeproxy

anddefensive

expansionproxyare

allhighly

correlated,so

only

usedhost

banking

market

proxy.This

proxypositiveand

significantin

some

cases

162 Barry Williams

share

ofhost

commercialbank

deposits

(4)Foreignbranch

return

onassets

Jain

(1986)

Aggregate

data

onacross

section

of46developing

countriesand7

EasternEuropean

countriesin

which

U.S.bankshad

assetsbetween

1977and1982

Square

rootof

U.S.bank’sshare

ofloansto

the

country

U.S.share

oftotal

exportsand

importsto

the

country

OLSregression.

Influentialvari-

ablesidentified.

Separate

regres-

sionsforeach

year

1982resultsonly

reported.Trade

proxypositiveand

significantat1%

level

foronecase

outof17

regressions

Poulson

(1986)

Japanesebanksin

theU.S.1972:4

to1980:2,quarterly

aggregate

data

Commercialand

industrialloans

ofU.S.offices

ofJapanesebanks:

(1)Nominalvalues

(2)Realvalues

TotalJapanese

tradewiththe

U.S.

OLStimeseries

regressions

Proxypositiveand

significantin

all

cases

Cooper

etal.

(1989)

Foreignowned

banksin

the

U.S.195foreign

owned

banksfrom

19countries,1980

to1986.Annual

data.Sample

AllBanks:

(1)Commercialand

Industrial

(C&

I)loansto

U.S.locations

divided

by

C&

Iloansto

Net

tradebalance

foreach

bank’s

homenation:

homecountry

merchandise

exportsless

homecountry

OLSapplied

topooleddata

Positiveand

significantfor

(2),negativeand

significantfor(3)

Notsignificant

otherwise


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

from

Europeand

PacificRim

non-U

.S.

locationsby

theU.S.

operationsof

thatbank

(2)C

&Iloansin

the

U.S.bytheforeign

bankin

U.S.

divided

bythat

bank’sglobal

C&

Iloans

(3)HoldingsofU.S.

Treasury

securities

byforeignbankin

U.S.divided

bynon-

U.S.C

&Iloans

(4)Loansto

U.S.

banksdivided

by

loansto

non-U

.S.

banks

(5)Loansin

theU.S.

divided

bynon-

U.S.loans

merchandise

imports

164 Barry Williams

Cooper

etal.

(1989)cont’d

Foreignowned

banksin

theU.S.

195foreignowned

banksfrom

19

countries,1980to

1986.

Annual

data.Sample

from

EuropeandPacific

Rim

EuropeanBanks.

(6)U.S.C

&I

loansdivided

by

non-U

.S.C

&I

loans

(7)U.S.C

&Iloans

divided

bytotal

C&

Iloans

(8)U.S.Treasury

holdingsdivided

bytotalnon-U

.S.

C&

Iloans

(9)Security

holdings

divided

bytotal

non-U

.S.C

&I

loans

(10)U.S.lettersof

creditsdivided

bynon-U

.S.

lettersofcredit

(11)Loansto

U.S.

banksdivided

byloansto

non-U

.S.banks

(12)TotalU.S.loans

divided

bytotal

foreignloans

Net

tradebalance

foreach

bank’s

homenation:

homecountry

merchandise

exportsless

homecountry

merchandise

imports

OLSapplied

topooleddata

Negativeand

significantfor(8)

and(9),not

significant

otherwise


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

Cooper

etal.(1989)

cont’d

Foreignowned

banksin

theU.S.

195foreignowned

banksfrom

19

countries,1980to

1986.Annual

data.Sample

from

EuropeandPacific

Rim

PacificRim

banks.

(13)U.S.C

&I

loansdivided

bytotalC

&I

loans

(14)U.S.Treasury

securities

divided

by

totalnon-U

.S.

C&

Iloans

(15)Loansto

U.S.

banksdivided

byloansto

non-U

.S.banks

Net

tradebalance

foreach

bank’s

homenation:

homecountry

merchandise

exportsless

homecountry

merchandise

imports

OLSapplied

topooleddata

Notsignificantin

anycase

EuropeanBanks.

(16)U.S.deposits

divided

by

non-U

.S.

deposits

(17)U.S.deposits

divided

bynon-

U.S.sources

of

funds.Pacific

Rim

Banks:

Net

tradebalance

foreach

bank’s

homenation:

homecountry

merchandise

exportsless

homecountry

merchandise

imports

OLSapplied

topooleddata

Notsignificant

inany

case

166 Barry Williams

(18)U.S.deposits

divided

by

non-U

.S.

deposits

(19)U.S.deposits

divided

by

non-U

.S.

deposits

Goldberg,

Helsley

andLevi

(1989a)

Foreignbanksin

theU.S.in

1984,

state

level

data

(31states)

(1)Foreignbank

assets

(2)Foreignbanks

deposits

(a)State

imports

(b)State

exports

OLS

(a)Positiveand

significantin

all

cases

(b)Negativeand

significantin

all

cases

Goldbergand

Johnson(1990)U.S.banksin

22countries.

1972–1985.

Aggregate

annual

data

(1)Assetsofforeign

branches

(2)Number

of

foreignbranches

Exportsdivided

by

GNP

Pooled

regressions,

N¼

240

Tradeproxypositive

andsignificant

Terrell,

Dohner

andLowrey

(1990)

(1)Japanesebanks

intheU.K

.(2)Japanesebanks

intheU.S.

(1)Nonsterling

assetsof

Japanese

branches

inthe

U.K

.

(a)Japanesetotal

tradewiththe

U.K

.(b)Japanesetotal

tradewiththe

U.S.

OLS

Tradeproxies

positivelyand

significantlyrelated

toboth

totalasset


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

Quarterly

aggregate

data.1980:1

to1988:4

(UK

Branches),1980:2

to1988:(U

Sactivity)

(2)Totalassetsof

Japanesebanks

intheU.S.

(3)Commercialand

Industrial(C

&I)

loansofJapanese

banksin

theU.S.

(4)Interbankclaim

sofJapanese

banksin

theU.S.

measures.C&I

loanspositively

relatedto

trade

measure.Interbank

claim

snot

significantlyrelated

totrademeasures

Budzeika

(1991)

Foreignbanksin

theU.S.,annual

andquarterly

data,

1974:4

to1989:4,

aggregate

data

(1)Totalassetsof

foreignbranches

andagencies

(2)Commercialloans

offoreign

branches,

agencies

and

international

bankingfacilities

(IBFs)

Exportsplus

importsfrom

the

ithnation

Forw

ard

stepwise

regressions.

Allvariablesin

firstdifferences

oflogarithms.

N¼17(annual

data)or68,

quarterly

data)

(1)Positiveand

significantfor

both

annualand

quarterly

data

(2)Positiveand

significantfor

annualdata,

quarterly

data

notshown

168 Barry Williams

(3)Totalassetsof

foreignbranches,

agencies

and

IBFs

(4)Totalassetsof

foreign

subsidiaries

(3)Nosignificant

contribution,

coeffi

cient

positive,

annual

data

only

(4)Positiveand

significantifP/E

ratioincluded

inmodel,otherwise

positiveandnot

significant,

annualdata

only

Dohner

and

Terrell(1991)

33banksfrom

7developed

nations,

1977–1986.

Pooledcountry

bycountry

annualdata

TotalAssets

measuredin

USD

(1)Exportsplus

importsin

USD

scaledbyGNP

inUSD

ofthe

jthcountry

(2)Currentaccount

inUSD,scaledby

GNPin

USD

OLSand

Kmenta’s(1990)

Pooled

estimation,

exceptforUS

banks,which

failed

poolability

test,so

time

series

regressions

used

(i)Canada:(1)and

(2)notsignificant

(ii)France:(1)and(2)

notsignificant

(iii)Germany:

(1)positiveand

significant,(2)

notsignificant

(iv)Japan:(1)and

(2)positiveand

significant

(v)Switzerland

(1)negativeand

significant,(2)

positiveand

significant


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

(vi)UK:(1)not

significant,

(2)positiveand

significant

(vii)US:some

evidence

ofboth

(1)and(2)

havinga

significantand

positiveeff

ects

Grosseand

Goldberg

(1991)

Foreignbanksin

theU.S.,1980–

1988,bycountry,

aggregate

annual

data

(1)Foreignbank

assetsby

country

(2)Number

offoreign

bankoffices

Exportsand

Importsbetween

theU.S.andeach

sourcecountryin

U.S.D

.millions

Pooled

regressions

Tradeproxy

positiveand

significant

Heinkel

and

Levi(1992)

Foreignbanksin

theU.S.,cross-

section,aggregate

data

for1985

(1)Number

of

representative

officesfrom

each

country

(2)Number

of

agencies

from

each

country

Exportsfrom

homecountryto

theU.S.

Threestage

least

squares

regressions

Tradeproxypositive

andsignificantfor

(1)and(2).Some

evidence

ofcollin-

earity

betweentrade

proxyandU.S.

dollarvalue

170 Barry Williams

(3)Number

of

branches

from

each

country

(4)Number

of

subsidiaries

from

each

country

ofhome

stock

market

Wright(1993)

Foreign-owned

licensedbanks

operatingin

Australia,

1985–1992,

eighteen

banks

Annualdata

Logofassetsin

Australia

Importsplus

exportsbetween

homecountry

andAustralia

Tim

eseries

OLSregressions,

oneper

bank

Tradeproxypositive

andsignificantat

5%

level

andat1%

levelin

onecase,out

of18regressions

Goldbergand

Grosse(1994)

Foreignbanksin

theU.S.;state

by

state

annualdata

1981to

1989

(1)Totalassets

(2)Totaloffices

(3)Assetsof

agencies

(4)Number

of

agencies

(5)Assets

ofbranches

(6)Number

of

branches

(7)Assetsof

subsidiaries

(8)Number

of

subsidiaries

Importsplus

exportsper

state

divided

bystate

income

Poolederror

components

model

andOLS.OLS

resultsameas

pooled;only

OLSshown

Notsignificantfor

anyindependent

variable


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

Marashdeh

(1994)

Foreignbanks

inMalaysia,

1980–1990,from

11countries,

aggregate

annual

data

foreach

country

(1)Number

of

branches

and

officesfrom

each

country

(2)Number

of

officesfrom

each

country

Totaltrade

(exportsplus

imports)

with

thecountry,

inringgits

Pooled

regressions,fixed

effects

model

Tradeproxy

positiveand

significant,except

forofficesin

Malaysia,excluding

Japaneseoffices

Wrightand

Liesch(1994)

Foreignbanksand

foreignMerchant

banksin

Australia

1988to

1992.

Annualbank

data

pooled

(1)Logoftotal

assets

(2)Return

on

assetsafter

tax

Exportsplus

imports

Pooleddata

estimatedusing

OLS

(1)Positiveand

significantatthe

10%

level

(2)Positiveand

significantatthe

1%

level

Galiatsosand

Papapetrou

(1995)

Foreignbanksin

Greece,

1968to

1992,timeseries

aggregate

data,

(1)Assetsof

foreign

banks/Total

Greek

commercial

bankassets

Importsplus

exports/Greek

GDP

OLS

Positiveand

significantfor

(1)and(2)

172 Barry Williams

25annual

observations

(2)Number

of

foreignbank

branches

Wengel

(1995)

Foreignbanksin

141countries,

listed

inthe

Banker’s

Alm

anac(1990)

(1)Number

of

Branches

(2)Number

of

subsidiaries

(3)Number

of

representative

offices

Bilateraltrade6

7Logitregressions

Positiveand

significantforboth

(1)and(2)

Brealeyand

Kaplanis

(1996)

1000largestbanks

in1992

Logofnumber

ofbanksfrom

countryiin

host

nationj

(a)Exportsto

parentcountryi

(b)Im

portsfrom

parentcountryi

(1)OLSwith

Whites

correction

applied

topooleddata

(2)Separate

regressionfor

each

trade

variable.OLS

forselected

individual

nations,(A

)Parentnation

regressionsand

(B)Hostnation

regressions

(1)Positiveand

significantfor

both

(a)and(b)

Exportsonly

shown

(2A)11of13

coeffi

cients

positive,

6significantat

95%

level.On

average

explanatory

power

increased

by6%

dueto

exportsvariable

(2B)All9coeffi

cients

positive,

4


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

significantat

95%

level.

Generallyhost

nation

regressions

hadlower

explanatory

power

Fisher

and

Molyneux

(1996)

Foreignbanksin

London,1980to

1989.Annual

aggregate

data

(1)Number

of

banks

(2)Number

of

staff

(3)Number

of

banksfrom

Europe

(4)Number

of

banks,

excluding

USA

andJapan

(5)Number

of

stafffrom

Europe

(a)Bilateraltrade

(b)Im

portsinto

theUK

(c)Exportsfrom

theUK

PooledData

with

missing

observations:

techniquenot

clear,could

beOLS

(a)Positiveand

significantfor

(1)and(2)

(a)Negativeand

significantfor(3).

Notsignificant

for(4),(5)and

(6)

(b)Negativeandnot

significantfor(1)

Positiveand

significantfor(2)

(c)Positiveand

significantfor(1)

and(2)

174 Barry Williams

(6)Number

of

Staff,excluding

USA

andJapan

Overall:exports

increase

bank

presence,while

importsare

more

equivocal

Hondroyiannis

and

Papapetrou

(1996)

Foreignbanks

inGreece1981

to1992,annual

aggregate

data

(1)Totalassets.

(2)Number

of

branches

Importsinto

Greecefrom

Homecountry

PooledData,

model

estimated

usingerror

correctionmodel

withcorrection

forautocorre-

lation

Positiveand

significantfor

both

(1)and(2)

Moshirianand

Sim

(1996)

U.S.bank’s

1970–1992,

annualaggregate

data

U.S.banksforeign

assets.(N

ote

thisis

astudyof

internationalrather

thanmultinational

banking

U.S.exportsof

goodsdivided

byU.S.G.N

.P.

(a)Ordinary

Least

Squares

(b)Instrumental

Variables,

(c)Generalised

Methodof

Moments

Positiveand

significantfor

(a)and(c),

positiveandnot

significantfor(b)

Tschoegl

(1997)

ForeignBanksin

Norw

ay.

(See

nextcolumn)

(1)Binary

dependent

variable:value1

ifoperatingin

Norw

ayandin

Euromoney

top

20FX

dealers

in1985

(a)LogofNorw

ay’s

importsfrom

each

bank’shome

country

(b)LogofNorw

ay’s

exportsfrom

each

bank’shomecountry

OLS

(1)Nosignificant

relationship

for

either

(a)or(b)

(2)Significantand

positivefor(a).

Significantand

negativefor(b)


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

(2)Binary

dependent

variable:value

1ifoperating

inNorw

ayand

inTheBankers

top50bankslist

in1985

Millerand

Parkhe(1998)

U.S.banksin

32countries,

1987–1995

(office

types);

1990–1995

(assets).Annual

aggregate

data

(1)Assets:

(1a)Alloffices

(1b)Branches

(1c)

Subsidiary

(2)Number

ofOffices:

(2a)Alloffices

(2b)Branches

(2c)

Subsidiary

(3)TotalAssets

(3a)Industrial

Countries

Bilateraltrade

betweentheU.S.

andtheith

country

Pooleddata

estimatedwith

OLS,White’s

(1980)correction.

Missing

observations

deleted,(n¼

270

foroffices;

n¼

140forassets)

(1)Negativeand

significantin

all

cases

(2)Negativeand

significantin

all

cases

(3)Negativeand

significantfor

(3a),positiveand

notsignificantfor

(3b)

(4)Negativeandsig-

nificantfor(4a),

positiveandnot

significantfor(4b)

176 Barry Williams

(3b)Developing

Countries

(4)Branch

Assets

(4a)Industrial

Countries

(4b)Developing

Countries

(5)Subsidiary

Assets

(5a)Industrial

Countries

(5b)Developing

Countries

(6)Office

Numbers

(6a)Industrial

Countries

(6b)Developing

Countries

(5)Negativeand

significantfor

(5a),positiveand

notsignificantfor

(5b)

(6)Negativeand

significantin

allcases

Millerand

Parkhe(1998)

[cont’d]

U.S.banksin

32countries,

1987—1995

(office

types);

1990–1995

(assets).

Annual

aggregate

data

(7)Branch

Offices

(7a)Industrial

Countries

(7b)Developing

Countries

(8)Subsidiary

Offices

Bilateraltrade

betweentheU.S.

andtheith

country

Pooleddata

estimated

withOLS,

White’s(1980)

correction.

Missing

observations

(7)Negativeand

significantin

all

cases

(8)Negativeand

significantin

allcases


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

(8a)Industrial

Countries

(8b)Developing

Countries

deleted,

(n¼

270for

offices;

n¼

140forassets)

Williams

(1998a)

Foreignbanksin

Australia

1987–1993

Annualbank

data

(1)Assetsin

Australian

dollars

(2)Return

on

Assetsafter

tax

Australianexports

tobank’shome

country68

Cross

section

bounded

regressions,

yearbyyear

(1)Negativeand

significantin

most

years

(2)Positiveand

significant

in1987,not

significant

otherwise

Williams

(1998b)

Foreignbanks

inAustralia

1987–1993

Annualbank

data

(1)Assetsin

Australian

dollars

(2)Return

on

Assetsafter

tax

Australianexports

tobank’shome

country69

Unbalanced

pooled

regressions

(1)Positiveand

significant

(2)Someevidence

ofanegativeand

significant

relationship

Yamori(1998)

Japanesebank

offshore

expansion,

1951to

1994

(1)Logof

accumulated

stock

of

Japanese

(a)Logofvolume

oftrade(exports

plusim

ports)

betweenJapan

OLS

(1a)Positiveand

significant

(1b)Positiveand

significant,

178 Barry Williams

bankFDIin

theithhost

nation,1951

to1994

(2)Logof

accumulated

stock

of

Japanesebank

FDIin

theith

host

nation,1990

to1994

andtheith

nation

(b)Logofexports

betweenJapan

andtheith

nation

(c)Logofim

ports

betweenJapan

andtheith

nation

when

included

with(c),butnot

(a);(c)negative

andsignificant

(c)Negativeand

significantif

included

with

log(FDI+

Exports)

instead

of(a)or(b)

(2a)Positiveand

significant

(2b)Positiveand

significant,when

included

withc);

(2c)

negativeand

notsignificant

Evidence

of

collinearity

Konopielko

(1999)

Foreignbanksin

Poland,Hungary

andtheCzech

Republic

0ifbanksnot

present,1if

bankpresent

(a)Im

ports

(b)Exports

(measurement

notclear)

(a)Logit

regressions

(b)OLS

Poland:Im

ports

negativeandsignifi-

cant,Exportsposi-

tiveandsignificant

Hungary:

Importspositiveand

notsignificant,

Exportsnegative

andnotsignificant


Table

2:Continued

Author

Subject

Dependent

Variables

TradeFinance

Proxy(Independent

Variable)

Estim

ation

Method

Result

Czech

Republic:

Importspositiveand

notsignificant,

Exportsnegative

andnotsignificant

Buch

(2000)

Offshore

banking

byGermanbanks

1981to

1998

Annualaggregate

date.Studycovers

upto

37countries

ofoperationby

Germanbanks

(1)LogofFDIby

Banksin

1997

(n¼

20)

(2)Changein

log

offoreignassets

ofdomesticbanks

1982to

1998

[international

banking]

(n¼

462)

(3)Changein

log

ofassetsof

foreignbranches

1981to

1997,

(n¼

477)

(4)Changein

log

ofassetsof

foreign

(a)Logof

Exportsplus

Imports

(b)Logof

Exportsplus

importslagged

byoneperiod

(c)Changein

log

ofexportsplus

importslagged

byoneperiod

OLSwithWhites

correctionfor

cross

section

study.Panel

estimations

controllingfor

non-stationarity,

errorcorrection

model

forpanel

data,fixed

effects

estimation

(1)(a)Positiveand

significant

(2)(b)and(c)

Positiveand

significant

(3)Tradefinance

proxynotused

(4)(b)Positiveand

significant

Note:Buch

alsoused

LogofFDIbybanks

aover

theperiod

1981to

1997(?)as

adependentvariable

inpanel

regression,

withlogofim

ports

asanindependent

variable.Theresults

180 Barry Williams

subsidiaries

1987to

1998,

(n¼

390)

Note

(1)isastock

variable,(2)to

(4)

are

flow

variables

ofthisregression

werenotshownin

thepaper.Buch

foundim

portsto

benegativeand

significant.(see

page51)

Moshirian

(2001)

FDIin

banking

from

Germany,

U.K

andU.S.

from

1983

(1)to

1995(4)

Quarterly

aggregate

data

Changein

log

ofbankforeign

assets

Changein

logof

bilateraltrade,

bilateraltrade

foreach

nation

weightedbyFDI

GMM

estimation

Separate

regressionsfor

each

nation

Bilateraltrade

positiveand

significantin

all

cases.Trade

effectsignificantly

stronger

for

Germany

65GoldbergandSaunders(1981b)consider

thisvariableameasure

of‘‘foreignfirm

penetrationinto

theU.S.markets....’’(p.370).

66GoldbergandSaunders(1981b)considered

thisresultto

dueto

agencies

conductingmuch

oftheiractivityin

tradefinance.,see

p.367.

67Thisvariable

appears

tohavebeenadded

totheMNC

asset

size

measure.

68Im

portswerefoundto

behighly

correlatedwithcapitalflow

andalsohighly

correlatedwithexports.Exportsdid

show

ahigh

correlationwithcapitalflow.Both

FDIandtrademeasureswereusedto

determinewhichclients

multinationalbankswere

accompanyinginto

thehost

country.

69See

footnote

above.


trade needs), to the establishment of locally incorporated bank subsidiaries.26

This shift in focus is consistent with the defensive expansion argument of banks

following clients abroad, and indicates that trade measures are not necessarily

the best measure of the impact of defensive expansion motivations upon

multinational banking. A subsequent study by Moshirian and Van der Laan

(1998) considered a wider range of nations (U.S., U.K. and Germany) and

found the same result. Buch (2000, p. 50) found the same result for German

banks, using a longer time period and a different estimation method.27 This

argument could act as a partial explanation, (alongside collinearity problems),

for the mixed results found by Fieleke (1977), Dohner and Terrell (1990) and

Fisher and Molyneux (1996).

When studying multinational banking, Tschoegl (1997) also found a

substitution effect. However, in this case, as Norwegian exports increased, so

multinational banking in Norway decreased. Williams (1998a) found similar

results for foreign bank size in Australia, as did Goldberg et al. (1989a) in

the United States. These results are not incompatible with those of

Moshirian and Sim (1996). It can be concluded from this evidence that as

a bank’s home nation exports increase, so the opportunities for provision of

financial services, in both a multinational and international context, will

increase for banks from that country. Thus, increased exports from the ith

country are observed to result in the ith country banks expanding offshore.

Banks from the ith country are now able to provide multinational services

previously supplied by foreign banks operating in the ith country. The result

is a substitution effect. Goldberg et al. (1989a) argued that the substitution

effect could be due to exports being financed by the importing corporation in

the destination nation, thus producing the negative relationship between

foreign bank size in the host nation and exports. Goldberg et al. (1989a) also

argued that exporters will have foreign currency receivables and so have

incentives to borrow in these currencies and so generate a natural hedge. The

strength of this argument is somewhat reduced by the prevalent use of the

U.S. dollar in trade transactions. However, it is also not entirely clear that

the effects of imports and exports upon multinational bank performance can

be separated.

Williams (1998a and 1998b) found export and import measures to be highly

correlated. These measures were treated as interchangeable alternatives for

measuring trade finance effects. Miller and Parkhe (1998) also found this high

26 St-Hilaire and Whalley (1995) also consider this distinction important in order to measurecross-border flows in banking services.27 Buch (2000) also considered that banks must choose between multinational banking andinternational banking. However, Buch assumed that once the choice is made to adopt a mul-tinational banking strategy that this choice is irreversible due to the need for a branch network.Given the range of organisational forms available to the multinational bank, this assumption ofirreversibility is perhaps a little strong. Further, the empirical tests employed by Buch (2000) didnot address the issue of substitution between international and multinational banking.

182 Barry Williams

correlation, and were not able to discern any difference between the use of

imports, exports, or imports plus exports, consistent with Williams (1998a and

1998b). Grosse and Trevino (1996) found imports and exports to be correlated

at 0.82, but argued that this correlation did not impact on the sign or

significance of the other variables in their model. Thus, in many cases, it may not

be empirically possible to determine the extent of the substitution effects

discussed by Moshirian and Sim (1996) and Tschoegl (1997).

Due to substitution effects, exports and imports may have different effects

on the pattern of expansion by multinational banks when seeking to defend

their client base. However, some authors have not considered these effects

separately, and have instead measured bilateral trade (exports plus imports).28

Such studies include Fielecke (1977), Terrell (1979), Dean and Giddy (1981),

Cho (1985), Dohner and Terrell (1990), Miller and Parkhe (1998), Buch

(2000) and Moshirian (2001).29 While this approach does not allow any

conclusions to be drawn regarding the substitution between multinational

banking and international banking, it can be justified on the basis of the

potentially high correlation between exports and imports. This potentially

high correlation should be considered before any conclusions can be drawn

regarding substitution effects. In such a situation the researcher would be well

advised to consider using an appropriate instrumental variable before any

substitution effects could be accurately identified.30 Those studies that used

bilateral trade to measure defensive expansion effects generally found support

for banks expanding offshore to follow the trading activities of their clients.

As found by Grosse and Trevino (1996), the separate inclusion of imports and

exports in the same equation results in the two variables having opposite

signs, (imports, negative; exports, positive).31 Goldberg et al. (1989a) observed

that the import effect dominated the export effect, indicating that interna-

tional trade increases financial activity at the margins, as well as increasing

economic activity. Yamori (1998) dealt with this issue by using several

28 Cooper et al. (1989) used a variation on this theme and employed a measure of the net tradebalance (exports minus imports). However the trade balance measure was found to have limitedempirical significance, see Table 2.29 Moshirian (2001) used a weighted measure of bilateral trade in which bilateral trade by theith country (dependent variable nation) with the jth country was given a weight. The weight wasthat proportion of the ith countries total FDI in the jth nation. The weight was a constant forthe time period studied by Moshirian (2001).30 It would be expected, for example, that home nation GNP would be highly correlated withhome nation imports, but home nation GNP would have a lower correlation with home nationexports. Thus it could act as an appropriate instrumental variable for home nation imports.However, home nation GNP may also reflect relative growth effects (Goldberg and Saunders,1981a) or the opportunity costs of offshore expansion. These alternatives require careful choiceof the appropriate instrumental variable, and may complicate the accurate interpretation of anyresults.31 Grosse and Trevino were investigating the causes of FDI into the United States. Konopielko(1999) found a similar effect but did not address these issues. Buch (2000) also considered thisissue.


different specifications of the defensive expansion measures applied to his

model.32 Grosse and Trevino (1996) speculated that the negative sign on

imports could reflect the competitive advantage of the United States vis a vis

the other country, resulting in less opportunity for foreign firms to invest in

the U.S. This competitive advantage argument is consistent with substitution

between international banking and multinational banking, but is not

conclusive due to the difficulties of statistical inference in the presence of

multicollinearity.

Substitution Effects and Developing Nations

The nature of the substitution effects differs between industrialised and

developing nations (Miller and Parkhe, 1998). In the case of industrialised

nations, a clear pattern of substitution between international banking and

multinational banking was observed for the trade measure. However, in the case

of developing nations, trade patterns were not observed to have any impact on

asset size, and the substitution effect was most apparent for office numbers.

However, Miller and Parkhe (1998) found strong evidence of a substitution

effect for developed nations. It was argued that this was possibly due to a net

suppression effect caused by the inclusion of an FDI measure in the same model,

obscuring the relationship between the dependent variables and the trade

measures.33 Miller and Parkhe (1998) concluded that a substitution effect was a

likely cause of their result, and argued that this could have been reinforced by a

currency clientele effect. Miller and Parkhe (1998) also argued that the ability to

provide trade finance at a distance for the trading nation, via electronic delivery,

removed the need for a physical presence to finance trade in developed banking

systems. The currency clientele effect (Yannapoulos, 1983) argues that bank

clients will seek banks with a home market in the country of origin of the

currency of transaction.34 As Miller and Parkhe’s (1998) sample was drawn from

U.S. banks in offshore markets, and the U.S. dollar is the main currency of trade

transactions, this is a reasonable conclusion. However, the finding of a

substitution effect outside the U.S. case indicates that the substitution effect

32 Yamori (1998) found the log of volume of trade (exports + imports) to be highly correlatedwith log of FDI and so used log (FDI + exports) to overcome this problem. Buch (2000) alsofound FDI measures to be highly correlated with trade measures and so used bilateral trade asan alternative for FDI. The study by Buch (2000) was conducted for German banks only. TheEuropean focus of both trade and investment, as well as the single nation focus are likelyexplanations for this high correlation.33 Miller and Parkhe (1998) considered the issue of multicollinearity, but stated that the in-fluence diagnostics did not support this conclusion. However, Miller and Parkhe (1998) appliedOLS estimation, with White’s (1980) correction for heteroskedasticity to pooled time seriescross section data, thus the estimation technique applied was not entirely appropriate to thedata type. As a result the underlying assumptions of OLS estimation may have been violated,leading to the possibility of biased, inconsistent or inefficient estimators (Hsiao, 1986; Baltagi,1995).34 See also Cooper et al. (1989), p. 4 and Sagari (1992), p. 101.

184 Barry Williams

extends beyond a currency clientele effect involving the U.S. dollar.35 Miller and

Parkhe’s (1998) finding that the substitution effect was not as apparent for

developing nations provides further evidence in this direction.36

Developing nations, by definition, will not possess a banking system that is as

sophisticated as those in developed nations.37 Thus, the option of providing

trade finance at a distance, via correspondent banking, is not as viable an option

as it is in developed nations. Miller and Parkhe (1998) found that trade flows

increased the number of offices in the host nation, but had no impact on asset

size. Thus, given the less developed nature of developing nations banking

infrastructure, a physical presence is required to oversee trade finance. The

alternative of the traditional (industrialised nation) model of relying upon

delegated monitoring via correspondent banking is not seen to be as satisfactory

as a physical, transaction-based presence. This physical presence linked to trade

finance, changes the usual cost-benefit relationship regarding the appropriate

location to book such trade loans.38 This produced the indeterminate result for

the trade measure in developing nations, as there now exists a stronger reason to

book trade loans locally rather than in the home market. Developed nations,

however, have more sophisticated financial markets and thus the scope for

substitution between alternative mechanisms to provide cross border transac-

tions is greater, without bearing the costs associated with less effective delegated

monitoring.

Information has a central role in the defensive expansion hypothesis, as well

as internalisation theory. Following clients may be motivated by the need for

effective delegated monitoring, (Ursacki and Vertinsky, 1992; Grosse and

Goldberg, 1991), as well as client retention. It is possible that the need for

delegated monitoring becomes more pressing in developing nations, due to the

relative immaturity of information dissemination resources in these nations.

Therefore, the motivations relating to defensive expansion may differ for

developing nations. Thus the use of internalisation theory provides a coherent

35 As Tschoegl (1997) has found evidence of substitution effect in studies extending beyond theU.S. case, the currency clientele argument is at best a partial explanation for any substitutioneffects.36 Cooper et al. (1989) found results that also suggest a substitution effect. Cooper et al. (1989)segmented their sample into European and Pacific Rim sub-samples and found that the be-haviour of the two sub-samples differed. However, this result cannot be considered to be asconclusive as that of Miller and Parkhe (1998), as Cooper et al. (1989) had developed nations inboth sub samples, and a Japan effect is likely to have produced the results for the Pacific Rim.Further, as shown in Table 2, the defensive expansion measure employed by Cooper et al.(1989) was generally insignificant.37 As one characteristic of developed nations, as opposed to developing nations, is the pos-session of a more sophisticated financial infrastructure.38 In this context the bank initiating the transaction can choose to locate the resulting assets (inan accounting and reporting sense) in one of two locations, head office or the host nation. Thecapital market imperfections in the host nation mean that monitoring from the head officebecomes more costly. As a result the transaction is booked in the host nation to ensure optimalmonitoring.


framework for the interpretation of these results, that are at first slightly

contradictory.

Do Trade Measures reflect Defensive Expansion?

Trade and direct investment serve similar purposes in global resource allocation

and firms will select investment as an alternative to trade only if there are

barriers to trade (Walter and Gray, 1983). Thus, in some cases banks may follow

trading activities and, in others, investment activities. Trade financing has also

been suggested as relating to expertise in managing currency risk, or expertise in

a particular currency. This could be related to the currency clientele argument of

Aliber (1984) and Yannapoulos (1983). It has also been argued that the

provision of trade financing is an important transaction-based service, in which

multinational banks have considerable expertise (Cho, 1985). By specialising in

the provision of trade-related services, the multinational bank establishes

procedures and technology to conduct these transactions at low cost.39 Thus, by

expanding into countries with which the bank’s home country has considerable

trade links, the multinational bank is continuing to provide services in which it

has a low marginal cost of production. It is not clear if following trade-related

clients, product specialisation, or currency specialisation influences the source of

this lower cost of production.40 Thus, the defensive expansion hypothesis is not

unambiguously supported by evidence based upon trade finance measures.

The use of investment and trade variables to measure defensive expansion

effects by authors such as Fieleke (1977), Terrell and Key (1977), Khoury (1980),

Goldberg and Saunders (1981a) and Ball and Tschoegl (1982) was criticised by

Jain (1986). It is not clear if the investment or trade measures used in these

studies were in fact a double counting of the same activity. Jain (1986) argued

that this problem would be particularly prevalent when banks advance funds

specifically tied to a trade transaction. In this case the bank loan and the trade

measure double count the same transaction. When estimating such a relation-

ship empirically, researchers are in fact testing a tautology.41 Overall, internali-

sation theory provides a basis for interpretation when using trade finance

measures, and that is one of market failure. However, internalisation theory

alone does not aid in determining which aspect of market failure is being

measured by trade finance variables.

39 This is consistent with the surplus entrepreneurship hypothesis of Kindleberger (1969) andGrubel (1977).40 Each of these firm specific advantages can be considered as examples of market failure. Ineach case the firm possesses particular skills or resources, which are not readily tradeable in theopen marketplace and require a physical presence for its full exploitation.41 Jain (1986, p. 74) argued that this problem is ‘... less serious..’ when the proportion of bankloans due to trade financing is small. This problem appears to be an inescapable problem inresearch of this type.

186 Barry Williams

Buch (2000) considered that measures of Foreign Direct Investment are

potentially endogenous to a model of offshore activity by banks. As a result

Buch employed a measure of bilateral trade (imports plus exports) as an

alternative measure of following clients. While this approach dealt with the

problem of simultaneity between foreign direct investment and multinational

banking, it did not deal with the endogeniety of the trade measures. However, as

will be discussed below, a time series approach, as also used by Buch (2000),

offers a mechanism to overcome this problem.

Defensive Expansion and Economic Cycles

The study by Dohner and Terrell (1991) differs from many of the conventional

studies of defensive expansion. The usual procedure is to test for a relationship

between some measure of multinational banking, such as foreign bank assets

and the defensive expansion proxy. Dohner and Terrell (1991) tested for a

relationship between total assets of multinational banks, including domestic

assets and two defensive expansion proxies, with all variables being scaled by

GNP. The Dohner and Terrell (1991) study used total bank assets as a measure

of both domestic and multinational banking. Thus, it is not clear if this

approach actually measured the determinants of the multinational portion of the

balance sheet, or if it measured the macroeconomic factors determining the

domestic portion of total assets. This is due to two problems. The first is

associated with scaling by GNP, as discussed below. The second problem is that

banks from countries with increasing foreign investment and trade will also

experience increasing domestic demand for banking services, as discussed in the

model proposed by Khoury (1979). Thus, the results of Dohner and Terrell

(1991) should be viewed with some caution in the context of determinants of

multinationality. This is further supported by the concern of Terrell, Dohner

and Lowrey (1990)42 that trade measure may be collinear with other economic

cycle variables, as also found by Goldberg and Grosse (1994). Goldberg and

Grosse (1994) found local financial market size to be highly correlated with trade

and FDI measures. Brealey and Kaplanis (1996) also found imports and exports

to be highly correlated with GDP. Further, Brealey and Kaplanis (1996) found

that both home and host GDP have a major impact upon the number of foreign

banks in the host nation, and that the incremental impact of trade variables was

far smaller.43 Buch (2000) found that the elasticity of foreign activity with

respect to host nation GDP (above 1) was greater than that for FDI (below 1)

for the German case. Moshirian (2001) also found that host nation GDP is

42 A summary of this paper was published in the Federal Reserve Bulletin, V16, N2, pp 39–50.The full version was published in the North American Review of Economics and Finance, V1, N1,pp 53–73.43 Brealey and Kaplanis (1996) found that host GDP explained on average 31% of the locationdecision, parent GDP explained on average 57% of the location decision, but that the tradevariable had an incremental R2 of between 0.04 and 0.07. See Tables 1 and 2 for more details.


particularly relevant for German banks. Thus, care should be taken to allow for

economic cycle effects when including trade variables to measure defensive

expansion effects.

Several authors (Cho, 1985; Dean and Giddy, 1981) scaled the investment

measure that is acting as a proxy for defensive expansion, by host GNP. In a

similar vein, Dohner and Terrell (1991) scaled a trade measure by GNP, as did

Moshirian and Sim (1996).44 However, the host size hypothesis (Klopstock,

1973; Nigh et al., 1986; Wengel, 1995) considers that foreign banks expand into

new markets due to the opportunities offered in that market. When scaling the

investment proxy by GNP it is not clear if the new variable is measuring host

market opportunities or defensive expansion. A further problem in this vein is

the correlation observed between trade measures, host market size and

investment measures. This issue was discussed by Jain (1986), and then found

empirically by Jain (1986), Cho (1985) and Goldberg and Grosse (1994). The

study by Dohner and Terrell (1991) also showed some evidence of collinearity

between trade measures and a capital account measure used to proxy investment

flows.45 Moshirian and Sim (1996) also found evidence of collinearity between

several of the economic variables used, and unlike many of the previous studies,

addressed this issue with both instrumental variable and generalised method of

moments estimation. Thus, unless attention is paid to the estimation technique,

it may not be clear if the banks are following clients, financing trade

opportunities, or expanding into a market that offers growth opportunities.

Defensive Expansion and Offshore Investment

As mentioned above, as an alternative to following the trading activities of their

clients, multinational banks may expand offshore to follow their client’s offshore

investment. In general, empirical tests have found foreign bank activity in the

host country to be significantly and positively related to investment activity from

the home country.46 Table 1 details these results. A survey of multinational

corporations from the United States operating in France, found that 52% of the

respondents retained their traditional bank relationship when expanding in to a

new country (Pastre, 1981). Seth and Quijano (1991) conducted an analysis of

Japanese banks operating in the United States, but they did not provide any

44 Moshirian and Sim (1996) modelled the provision of international financial services, ie in-ternational banking, rather than multinational banking.45 This is not surprising, as both trade patterns and capital flows would potentially representdefensive expansion effects. However, as discussed previously there are some caveats associatedwith stating that trade measures reflect defensive expansion alone.46 This evidence is strongest for industrialised nations, in the case of developing nations theevidence is less unambiguous. Miller and Parkhe (1998) found no evidence for FDI affectingmultinational banking in developing nations, while Sabi (1988) found U.S. FDI in the hostnation increased U.S. branch assets in 23 LDCs. However, mutual causation may account forSabi’s (1988) results, as discussed earlier. As indicated in a previous footnote, there are potentialconcerns with the estimation method applied by Miller and Parkhe (1998).

188 Barry Williams

empirical results. Nevertheless, Seth and Quijano (1991) considered that

Japanese banks at first lend mainly to Japanese non-banks. They observed that

this pattern has now changed and the Japanese owned banks are now competing

actively with the U.S. banks, outside of the Japanese bank’s traditional client

base. This is consistent with the beachhead argument of Fieleke (1977), as

discussed above. Seth (1994) drew similar conclusions, while arguing that

foreign bank entry had resulted in an increase in excess capacity in domestic

U.S. banks.47

Time Series Issues

The issue of time series properties in the defensive expansion effect has been

considered in relatively few papers to date. Those papers adopting a time series

approach have reached slightly different conclusions. Sabi (1995) tested the

defensive expansion hypothesis using Granger causality, and found that foreign

bank investment in the host nation Granger-causes non-bank foreign direct

investment, but that non-bank foreign investment does not result in foreign

bank investment. These results do not imply that the defensive expansion effect

does not initially result in foreign bank investment, but Sabi’s (1995) results do

yield the conclusion that defensive expansion does not sustain long-term foreign

bank investment. These results are confirmed, from a different perspective, by

Williams (1998b). Unlike Sabi (1995), Williams (1998b) studied the time series

effects of defensive expansion by incorporating a lagged measure of capital flow

into the estimated models. Williams (1998b) found that this lagged variable had

a significant relationship with foreign bank size in Australia, but not foreign

bank profits. The current values of capital flow were found to have no

relationship with either of the performance measures used. This study concluded

that there was evidence of a beachhead effect, although its economic value was

small, contributing, on average, $A100,000 to the size of foreign banks. Buch

(2000) also considered the time dimension in the defensive expansion effect and

found that within an error correction framework, the foreign branch assets of

German banks were increased by the total German FDI (including bank FDI)

from the previous period. The use of a lagged FDI variable by Williams (1998b)

and Buch (2000) offers one method of addressing the problem associated with

potential simultaneity between FDI and multinational banking activity.48 As the

FDI variable employed by Buch (2000) included Bank FDI, it is possible that

this result reflected the leader follower behaviour discussed by Barron and Valev

(2000).

47 The term excess capacity was not well defined or measured in Seth (1994).48 Cooper et al. (1989) also used one lag of all independent variables in order to determine anytime series effects. However, the lag of the trade measure used was not found to be significant.Further, Cooper et al. (1989) employed OLS estimation with pooled data, which may haveresulted in biased or inconsistent estimates.


Seth et al. (1998) found evidence to support the beachhead approach to

multinational banking in the United States, combined with some cyclical effects.

The analysis conducted by Seth et al. (1998) relied upon the assumption that all

U.S. bank borrowing by foreign non-banks in the U.S. was from foreign

multinational banks of the same nationality. The authors admit (page 8) that

this assumption is extreme. Further, their conclusions are drawn from the use of

the juxtaposition technique used by Seth and Quijano (1993), which does not

involve statistical testing. However, given these caveats, the study did demon-

strate that foreign banks in the United States extended their lending beyond

foreign non-banks of the same nationality, but that the nature of the beachhead

effect differed across nationalities of origin. The study of Barron and Valev

(2000) introduces an interesting second dimension to the time series issue by

demonstrating that larger banks tend to lead smaller banks into new locations.

This provides a further possibility that parent bank size interacts with the time

series properties of defensive expansion. The importance of controlling for

parent size is discussed in the next section.

Parent Size Effect: An Omitted Variable?

Many of the studies of multinational banking to date have focussed upon data

drawn at the industry level and have tested models using macroeconomic

variables. As discussed by Tschoegl (1997), care should be taken with the results

of studies of this type with regard to the defensive expansion hypothesis. Larger

banks are generally more likely to have MNCs from their home countries as

clients, and so are more likely to accompany these clients abroad. Such banks

are also more likely to have the volumes of trade financing that justify offshore

expansion. Thus, any study of defensive expansion should include a control for

parent size effects. The parent size effect argues that there is a causal relationship

between multinationality and size (Buckley and Casson, 1991; Dunning, 1988).

In the case of multinational banks it is not clear which firm attributes are being

measured by firm size. Bank capital base is considered to be a key determinant of

international competitiveness (Hirtle, 1991; Thornton, 1992). Measures of bank

size such as size of equity capital, size of deposits, assets, number of countries of

operation and Eurocurrency activity have been found to be highly correlated

with each other (Cho, 1985). Further, Barron and Valev (2000) argue that larger

banks (wealthier banks) are able to purchase information that allows superior

informed decisions about where to invest. This argument would indicate that

larger banks possess economies of scale advantages in information management.

Barron and Valev (2000) found that larger banks tend to lead smaller banks

offshore, at least in the U.S. case, thus size has an important role in offshore

expansion by banks, and its effects should be considered. Overall, it is not clear

exactly which attribute firm size is supposed to measure. However, given this

theoretical and empirical evidence, models of defensive expansion effects in

multinational banking that do not include a control for parent size effects will

190 Barry Williams

not be able to satisfactorily distinguish between the competing hypotheses

outlined above.

Does Following Clients Increase Profits?

Most studies to date have focussed upon the impact of following clients upon

some measure of foreign bank presence in the host nation. In general, the results

of these studies have supported the defensive expansion hypothesis, with the

caveats mentioned above. However, while following clients increases size of

presence in the host market, the impact on profits is more ambiguous. Relatively

few studies have considered the question ‘‘Does following clients increase

profits?’’ There have been three main approaches adopted to address this issue.

The first, and most common method, has been to respecify the dependent

variable as a profits measure and then use the same set of independent variables

as used in a size of presence equation (Cho, 1985; Williams, 1996, 1998a, 1998b).

In these cases the profits measure employed is typically return on equity or

return on assets in the host market.49 As Cho (1985) found the defensive

expansion measure to be highly correlated with the trade finance measure and

the host market measure, the host market measure was used. Thus, this study is

inconclusive with regard to the impact of following clients in the host market. In

the case of the other studies applying this approach, the evidence supporting

defensive expansion increasing profits in the host market is at best weak. The

single nation study of Williams (1996) found no significant relationship between

Japanese FDI in Australia and Japanese bank profits in Australia. Using a wider

sample of bank nationalities, Williams (1998a and 1998b) found that following

clients does increase profits, but that the economic impact was small.50

The studies by Molyneux et al. (1998) and Molyneux and Seth (1998) provide

the second strand of the application of the defensive expansion hypothesis to

multinational bank profits. In both of these cases the authors argued that profits

and growth in loans are determined as a simultaneous process. Previous studies

have considered profits and size of presence to be determined by the same

variables, but did not consider the potential simultaneity of their determination.

The studies by Molyneux et al. (1998) and Molyneux and Seth (1998) produced

separate models of profits and growth, which were then modelled simultaneously

using two stage least squares estimation. The defensive expansion measure,

(FDI), was included in the growth equation only and was not found to have a

significant relationship with the growth measure.

Studies of the profits of firms operating across borders must always contend

with the possibility that transfer pricing to minimise taxes will act to produce

49 Giddy (1983) focussed upon the profits of multinational banks, but the results did not includea defensive expansion measure.50 Williams (1998a) found that following clients increased profits in the first year of operations,but had no impact thereafter, consistent with the beachhead argument.


systematic biases. Due to the difficulty in determining the type and nature of

transfer pricing, this is an issue that will always accompany research of this type,

which will be discussed below. The third type of profits study that included a

defensive expansion measure, Waheed and Mathur (1995), employed an event

study methodology and so was able to circumvent the problems associated with

transfer pricing biasing the reported profits measure. Waheed and Mathur

(1995) considered the share market reaction to announcements of offshore

expansion by U.S. banks. Using the two day ()1, 0) standardised cumulative

average residuals from the event study, Waheed and Mathur (1995) modelled the

factors that determined share price reactions. The defensive expansion measure

used, (FDI), was found to have a negative and significant relationship with the

residuals from the event study.51 The authors also attempted to determine if

there were any differences attributable to the organisational form adopted.

However, data availability problems limited the availability of the FDI measure

for most of the regressions focussing upon the impact of organisational form

choice. Thus, at this stage it is difficult to determine if the organisational form

adopted impacts upon the profitability of following clients.

Foreign banks in the U.S. have been found to be less profitable than domestic

U.S. banks (De Young and Nolle, 1996; Peek et al., 1999). These lower profits

have been attributed to input inefficiencies resulting from an over-reliance upon

purchased funds (De Young and Nolle, 1996).52 Peek et al. (1999) found that

this lower profitability, in the case of foreign acquisition of U.S. banks, could

also be attributed to the pre-acquisition features of the acquired banks. In

considering this lower profitability of foreign banks in the U.S., Peek et al.

(1999, p. 602) concluded ‘‘Even if the U.S. loans to those customers are not

particularly profitable, the lending relationship may still be in the best interest of

the bank.’’ Studies of foreign banks in the host nation are observing the marginal

contribution to profits of following clients abroad. However, foreign banks are

motivated by the value of the total banking relationship. The difference between

the motivation of the foreign banks and their observed performance may

account for the, to date, relatively weak support for the proposition that

following clients increases reported profits.

Overall, using three different approaches, the results to date indicate that

following clients does not increase bank profits. This conclusion must be

tempered by several caveats. The first is the relatively few studies of the impact

of following clients upon multinational bank profits. The next caveat is that

transfer pricing does introduce the possibility of biases in profits measures

obtained from publicly available data sources. It is unlikely that all banks in a

51 Waheed and Mathur (1995) found that the share market reaction to offshore expansionannouncements by banks was negative, but that there were differences between organisationalforms announced, with branches being a preferred organisational form.52 De Young and Nolle concluded that foreign banks in the U.S. actively sought to buy marketshare and were willing to sacrifice profits in pursuit of this goal.

192 Barry Williams

sample will be subject to the same transfer pricing incentives, due to factors

such as tax losses carried forward, different home nation tax rates and different

home nation treatment of foreign tax credits. Thus, the transfer pricing

problem can be dealt with to a certain degree by employing samples that

include banks from a variety of countries, and preferably utilising a long time

series.53 Berger et al. (2000, p 60) argued that their results were consistent with

global efficiency rather than ‘accounting shifts of income’. Finally, as pointed

out by Buch (2000, p. 38), it is possible there is a range of inaction due to entry

and exit costs. Thus, banks do not react immediately to changes in profits

unless they are substantial. Further studies of multinational bank profits using

long time series that incorporate longer lags in explanatory variables may prove

fruitful.54 Overall, the area of multinational bank profits has been relatively

neglected by the empirical literature. Much of this neglect is no doubt due to

difficulties associated with data availability. Thus, as data sources improve, the

study of multinational bank profits will provide fruitful opportunities for

research.

V. CONCLUSIONS: WHERE TO FROM HERE?

This paper has canvassed a number of issues relating to the study of the

defensive expansion hypothesis in multinational banking. Some of these issues

are those recurrent when conducting empirical studies in a wide variety of

circumstances, while other issues provide direction for future endeavour when

researching multinational banking. The potential causation between following

clients and the parent size effect dictates the need to employ firm level data in

any future studies. The need for firm level data is directed by the need to include

a control measure of parent size to accurately distinguish between the competing

alternatives offered by the parent size effect and the defensive expansion

hypothesis. This issue does bring with it some potential problems for research in

terms of data availability. An interesting possibility for further research is the

consideration of second order effects that may be discerned by including a

variable that measures the interaction between parent size and defensive

expansion measures.

The use of trade measures to measure the defensive expansion effect

introduces several ambiguities. The first is the question of whether a trade-

based measure reflects following clients, expertise in trade finance (and/or

foreign exchange expertise), or a parent size effect. The second ambiguity is due

to substitution effects between multinational and international banking. These

53 Thornton (1992) considered the impact of taxes upon Japanese bank size in London. Anegative relationship was found between Japanese bank size and tax rates. However, as this wasa single nation study and focussed upon size rather than profits, these results cannot be readilyextrapolated to cross border profits of banks.54 To date those studies that have employed a lag in independent variables have typicallyemployed one lag. The main exception to date has been Thonton (1992), see Table 1.


substitution effects are most apparent for developed nations, where the scope for

choosing between alternative delivery systems is greatest. The third source of

ambiguity is due to collinearity. The use of both import and export measures in

the same model introduces potential multicollinearity. Further, these trade

measures also exhibit tendency towards collinearity with other economic cycle

measures. Collinearity is an inescapable problem in research of this type, and its

potential impact upon empirical results should be considered. As with all

empirical studies, the issue of model specification should be considered at all

times. As previously mentioned, the role of economic cycle variables, particu-

larly their time series properties, should be examined with a view to their impact

upon any results. Care should also be taken when interpreting studies with a

small number of observations, particularly when the sample has a narrow focus

such as a single year or a single nation.

Overall, the results to date support the application of the defensive expansion

hypothesis to multinational banking, particularly when following clients is

considered in terms of foreign investment. However, care should be taken in

future studies to ensure that the chosen measure of foreign investment does not

include portfolio investment by fund managers. Portfolio investment is unlikely

to result in MNBs choosing to expand into a foreign market. This survey has

indicated that there exists more non-U.S. studies than previously considered (22

identified). Further, this survey has demonstrated that the total number of

studies of banks following clients abroad is greater than previously credited by

the literature.

While following clients abroad increases multinational bank size, it has not

been shown to impact significantly upon reported profits. The relatively few

studies of MNB profits to date means that the relationship between defensive

expansion and profits is ambiguous. As a result, the area of MNB profits offers a

potentially rich area of future research. The potential is reduced by problems

associated with data availability and quality of the available data. As with all

studies of cross-border profits, the issue of transfer pricing acts to cloud any

results. However, as argued in this paper, studies of cross-border profits should

include a range of firms from a variety of nations, preferably drawn over a

reasonable time period. Such a sample selection will help to ameliorate the

problems associated with transfer pricing. Relatively recent developments in

modelling bank profit efficiency also offer fruitful potential avenues for research

into multinational bank profits. Given that Berger et al. (2000) concluded that

global efficiency was the prime source of their results rather than transfer

pricing, this approach provides an avenue for a fruitful stream of future

research.

A further area of potentially valuable research is the dynamics of multina-

tional banking. The issues of beachhead effects and mutual causation have

received relatively limited attention to date. Given the advances that have been

made in time series techniques over the past two decades, there is considerable

scope for further research that offers potentially valuable insight.

194 Barry Williams

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VII. NOTE ON CONTRIBUTOR/ACKNOWLEDGMENTS

Barry Williams is Associate Professor of Finance at the School of Business,

Bond University, Australia.

The author is grateful for comments from John Foster, Ian Zimmer, Noel

Gaston, Art Goldsmith and an anonymous referee. All remaining errors remain

the responsibility of the author.


The Defensive Expansion Approach to Multinational Banking: Evidence to Date

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