Essays on banking in developing countries

[Monirul Islam]

This thesis consists of three essays examining different aspects relevant to the banking sectors of developing economies. The first two essays focus on Emerging Europe a region with one of the highest foreign bank presence in the world - to study the impact of foreign bank ownership and bank organizational structure on the cost of financial intermediation and terms of loan contracts. The last essay focuses on Kenya which is home to M-Pesa the mobile-phone based money trans-fer and financing service initially launched in Kenya in 2007 and subsequently in other emerging countries such as Albania, Romania, India, Egypt and several other African countries - to examine its impact on the performance and outreach of commercial banks.

The first essay investigates the impact of foreign bank entry, home and host country conditions on net interest margins (NIMs), using a newly collected panel dataset with ownership information for 265 banks operating in nine Southeast European countries over the period 1995 2011. As the banking sector of many emerging markets and in particular the European transition economies have been dominated by foreign banks understanding the impact of such reforms on host country banking sectors is important for designing supportive policies. We do not find evidence of foreign bank entry having a beneficial effect for host countries in terms of reducing the cost of financial intermediation in the long run, as foreign banks change their behaviour over time. We show that foreign banks have initially lower NIMs compared to domestic banks, however this effect weakens the larger the foreign presence and the more established foreign banks become. We find that home country regulation and supervision have an effect on bank behaviour, with foreign banks coming from countries with stricter regulation having higher NIMs in host countries.

The second essay studies the impact of institutions on bank organizational hierarchy. Studying the internal organizational structure of banks is important as it determines the type of information acquired and used in lending decisions and consequently the type of borrowers banks lend to. This is important not only for bank's loan portfolio composition and their financial soundness but also for borrower's ability to access funds on favourable terms and the overall financial system stability and economic development. Using a unique bank-level survey dataset covering 32 countries and 611 banks, we introduce a new and direct measure of organizational hierarchy and exploit the distinctive feature of multi-national banks which face different institutional environments in the countries they operate. We find that the same parent bank is more likely to grant decision-making authority to its foreign affiliates operating in countries with stronger institutions compared to those operating in weaker institutional environments. Combining the bank- with firm-level data we further find that a strong institutional environment which favours a decentralized organizational structure leads to better lending terms to SMEs decentralized banks grant loans with longer maturities, lower interest rates and are less likely to require collateral compared to their centralized counterparts. These findings further our understanding of bank organizational structure as a channel through which law affects lending.

In the last essay we use the advent of the mobile money innovation in Kenya in 2007 as an interesting laboratory to investigate the impact of a financial innovation on the performance and outreach of commercial banks. Providing more insights about this link is important as it helps inform the debate among policy-makers and regulators on the impact of a non-traditional source of competition on the service provision of formal financial institutions. Given that financial inclusion is a major problem in developing countries, detailed micro-level evidence on this issue is important for promoting household welfare. Combining the 2006, 2009 and 2013 FinAccess household surveys with bank financial statement and branch penetration data at the county level we find that banks more exposed to the competitive pressure induced by the mobile money innovation improved their performance and expanded their outreach towards households traditionally excluded by formal financial institutions. Additional results further show that households report less supply side barriers to financial access in counties more exposed to the advent of the mobile money innovation. These results highlight the importance of increasing the contestability of banking markets in order to promote financial inclusion and a more competitive banking sector.

Source: http://openaccess.city.ac.uk/18102/