Forms and Strategies of the Banks to Enter [600150]

Forms and Strategies of the Banks to Enter
on a Foreign Market

Nicoleta HURDUC
Bucharest Academy of Economic Studies
[anonimizat]
Alin NIȚU
Bucharest Academy of Economic Studies
[anonimizat]

Abstract. Main forms of entry on a foreign market are greenfield
investiments and achisition of a contro l position from a local institution.
Both forms, Greenfield and acquisitio n entry strategies, are specific to
CEE. In selecting the entry mode, one bank’s objective is to maximize its
risk-adjusted rate of return.
Searh for new markets strategy me ans that by some reasons banks
are always looking for ne w international market.

Keywords: international banks; cros s-border lending; banking
services; Greenfield investiments; achisitions; expansion of banks.

JEL Codes: E51, E52, G21.
REL Code: 11C.

Theoretical and Applied Economics
Volume XVIII (2011), No. 7(560), pp. 43-52

Nicoleta Hurduc, Alin Ni țu
44
1. Entry strategies
One of the ways to enter a new ma rket is to make foreign direct
investments. In fact, banks may pref er to engage in cross-border lending
without being physically present abroa d. The only way this can be done is
through a correspondent bank. This may be appropriate for services/
transactions already consumed, but not for expanding the business
opportunities. It is also not suitable for serving existi ng clients, even if they
have a strong and long-term relationship.
The relationship built through a corres pondent bank is therefore just the
first step to internationalize opera tions (Khoury, 1998, pp. 154-155). It is true
that there are numerous correspondent banking relationships. However, these
relationships are focused on relatively standardized produ cts, in particular on
the collection or payment of foreign funds, usually within trade finance
arrangements. It can be ar gued that correspondent banki ng relationship is not so
much an entry strategy as an alternative to genuine competition in foreign markets, particularly in areas which do not warrant full scale entry. The “sales approach” proposed by Franklin Root (see Table 1) is not as relevant to an
international bank as it w ould be to another trader. Banking services are not
easily provided without havi ng a trader in the target market. So making a direct
investment in a branch is a viable alte rnative. Entering a new market by using
the traditional foreign direct investments approach might mean ignoring the fact
that the foreign direct investments decisi ons are irreversible and they are made
in uncertain circumstances.
In banking, the issue of irreversibili ty of investments arises because
access to a branch network is crucial for the attraction of deposits and for
establishing long-term customer relati onships, thus for st arting building the
lending business. When deciding whether to enter a new market, banks have to
take into account three cost components : fixed costs to enter the new market
(which increase depending on the importa nce of legal entry barriers), fixed
costs to leave the new market, and operating costs.
The optimal investment policy of a ba nk must thus consider the value of
the real investment option: as information about the economic environment improves over time, it pays to wait and to postpone investment. Entry and exit
costs create a state of inaction: revenues ha ve to increase sufficiently before the
bank enters the non-traditional market, but once having entered the new market,
the bank can’t leave unless reve nues decrease substantially.

Forms and Strategies of the Banks to Enter on a Foreign Market
45
Table1
Short-term vs. long-term int ernationalisatio n approach
External sales approach Entry strategy approach
Time horizons Short term Long term (min. 3-5 years)
Target markets No systematic selection Selection based on the potential of the
market
Dominant objective Immediate sale Buil permanent bank-client relations
Resources used Resources needed for
immediate sales Resources needed for positioning on
the market
Entry mode No systematic choice Systematic choice
New product
development Exclusive sale on the domestic
market For both domestic and foreign markets
Product adjustments Mandatory adjustments to meet
legal/technical requirements Adjusting products to the local
preferences of the clients, to the income level and to the demographics
Sales channel No control Full control given by marketing
strategies
Price Depending on the domestic
market with some adjustments to specific sale situations Depending on the demand and supply
existing in the host country and on the marketing policy of the bank
Promotion Sales made by subcontractors Direct promotion
Source: Khoury, 1998, p. 155.
It is impossible to disc uss about the organizationa l structure or about the
activity level of the fore ign bank without referring to the banking legislation.
Dale (1986) points out that in almost al l banking systems regulation starts from
the early stage of market penetration. Some countries limit the entry of foreign banks to branches, while others prefer subsidiaries. The issue is with the compromise that has to be done between the local regulation and that from the
country of origin and the support of the local central bank.
Banking rules can discriminate betw een countries of origin, based on
bilateral treaties, reciproc ity reasons or industry st ructure. Alternatively, a
country may restrict the expansion of its banks abroad.
There are two forms of entry on a foreign market: 1) greenfield investment, which involves setting up an institution from
scratch. The newly established instituti on may require a capital infusion from
the beginning, but in some cases (a re presentative office or a branch) the
transfer is very limited or replaced only by the transfer of human capital;
2) acquisition of a control position from a local institution. Acquisition
size can range from a 100% purchase of the social capital of a given institution
to a minority stake.
Entering a market via greenfield inve stment allows the foreign bank to
take advantage of its international re putation, especially in less developed

Nicoleta Hurduc, Alin Ni țu
46
countries or less stable economies, wher e the depositors are looking for secure
placements. It also gives foreign banks the opportunity to address those market
segments that would not be reachable via a simple acquisition of a local entity.
By acquiring a control position from a local institution, foreign banks get
access to the profiles of the old local banki ng clients that might be incompatible
or at least inconsistent with the mark et positioning of the mother-bank, thus
requiring adjustments that might be e xpensive. However, inflows through
mergers and acquisitions have their advantages. For example, this type of foreign bank entry provides access to local knowledge. Moreover, if the
mother-bank's strategy calls for a global retail network, acquisition may be the most feasible alternative, especially if a rapid growth is desired. In addition, the
acquisition also provides immediate access to deposits, which allows an immediate signing up for local currency lending. Finally, acquisitions may be
advantageous for multinational banks wher e little is known about host markets.
Foreign banks are better positioned to offer products and services that
require a global platform, a considerable amount of capital that have a strong
technological content, as well as the e xperience and skills needed to provide
sophisticated products. Domestic banks are good in providing products and
services that require local abilitie s and knowledge, access to local currency,
possession of a branch network. The acqui red banks are more able to capture
these capabilities than thei r greenfield counterparts.
As a result, foreign banks tend to focus on corporate banking, while the
local banks concentrate on operating in retail banking and SME-s. Foreign
banks offer a wide variety of products : trade finance, project finance,
syndicated loans, foreign exchange se rvices, risk management products, cash
management services, financial advisory services, while the presence of the
banks on the local market can be used for working capital accreditation and
long-term investment loans granting (Pomerleano, Vojta, 2001).
Both greenfield and acquisition entry st rategies are specific to CEE and
have different characteris tics. First of all, chan ging the mono-banking system
into a two-tier banking system led to the fi rst wave of greenfield entries. Later,
the beginning of the priva tization process created opportunities for the foreign
banks to acquire local banks, thus lead ing to the second wave of market
penetrations and economic concentrations resulted from acquisitions.
The most attractive way of entering a new market is either by setting up a
new branch or by acquiring an existent bank. However, in the specific case of
Czech Republic, the up-most entry strate gy is by establishing a branch. This
reflects the permissive legislation from Czech Republic. In fact, since 1992 the
Law of Banks has opened the door to foreign branches, thus allowing the
release of operating licenses under le ss restrictive conditions. Expectation

Forms and Strategies of the Banks to Enter on a Foreign Market
47
approach was pursued by a number of i nvestment banks and some specialized
banks have preferred to open a bank’s representative office.
From the institutional point of view, the foreign investment is associated
with establishing or acquiring one of th e following organizational structures: a
local representative office, a branch office or a subsidiary. These “institutional”
vehicles for entry have different attr activeness for various types of banks.
Specialized banks, such as investment banks, will tend to operate through a number of representative offices or may even set-up a non-banking company.
The reason for this is that they usually do not perform typical banking activities (at least in the host country) that requi re a banking license . Regulators tend to
treat banks as special entities when they conduct typical activ ities i.e. collection
of bank deposits, money transmission etc.
When operations are limited to certai n consulting services, the risk is
lower and thus the host market regulation is becoming less important. Representative offices of foreign banks do not perform self-independent
activities, they rather attract and se t up businesses abroad for the mother
company.
Often, the representative offices of foreign banks also negotiate
correspondent relationships with domestic ba nks. It offers the banks a low cost
entry mode, allowing them to establish their brands without having any capital
costs related to setting up a branch or subsidiary. This activity provides a particular advantage when the entry va lue on the local market has yet to be
proven or the regulatory frameworks have a degree of uncertainty. Should
market development exceed expectations or certain profitable deals be granted
only to those banks present on the mark et, opening a representative office is
definitely an entry strategy.
For a wide range of industries, the lo west cost option to enter a foreign
market is to have a low level of owne rship. In selecting the entry mode, one
bank’s objective is to maximize its risk-adjusted rate of return. The degree of transaction control is seen as the single most important determining factor both
for risk and return. Cost is just one of the several elements determining the most
efficient level of the
Investment, the others might include financial infrastructure, foreign
exchange risk, competition and market size. A small market can lead to a less optimal investment and to the impossibility of reaching an appr opriate return on
capital employed.
A foreign bank representative offi ce is the most limited form of
organization and the less expensive one . Still it can not perform any kind of
activity. That is why it is mainly used for exploring busin ess opportunities from
a foreign country.

Nicoleta Hurduc, Alin Ni țu
48
A branch is not an independent legal entity, but an integral part of the
mother company. It can offer a comp lete range of banking services. The
decision making process is not fully delegated to the foreign branch and the activities of the branches are based on th e social capital of the mother company.
Foreign banks’ branches are subject to banking supervision both at home and in
the host country.
Subsidiaries of foreign banks are le gally independent from their mother
company and use their own capital for performing their activities. Hence,
foreign banks need to invest more capital abroad if they want to facilitate the same level of lending activity through a subsidiary rather than through a branch.
Branches are an integral part of th e mother company. A branch cannot fail
unless the mother-company fails. Subsid iaries and branches are separate
entities. A subsidiary may fail even if the mother company is solvable and vice versa, a subsidiary can be solvable even if its mother company is not. Under the
Basle agreements, the supervisory authorities from the host country are responsible for prudential s upervision of subsidiaries and the authorities from
the country of origin are responsible for the branches of the mother company. If
a foreign affiliate bank doesn’t have cont rol over its subsidiary, it has a clear
exploring role and doesn’t e xpress a long-term commitment.

Table 2
Forms of external presence
Representative
office Branch Subsidiary Minority
stake
Legal status Dependent Dependent Independent Independent
Investment costs Not necessary Necessary Necessary Necessary
Control capacity Direct Direct Direct and substantial Low control
Business intermediation Promoting Promoting Promoting Low
Flexibility Low High High Low
Number of employees Low Depending
on the level
of activity High N/A
Source: Bosch 2000, p. 38.
Foreign banks usually follow two different positioning strategies for
clients in emerging countries:
a. Making the most of th e foreign banks status , mainly devoted to their
international clients and to the top segm ent of the local market, like the large
local companies that need corporate banking, bonds issues or share listing.
Most are not active in retail banking outside their home market. Competition
can sometimes be very tough, because most foreign banks prefer to remain in this foreign bank position and the niche market becomes overcrowded.

Forms and Strategies of the Banks to Enter on a Foreign Market
49
b. Making the most of the local banks status , especially in countries that
allow foreign banks to get a license provi ding the same treatment as to domestic
banks. There are only a few international banks active in retail banking sector,
due to high barriers to en try in this segment, compared to, for example,
corporate banking. The distribution networ k is very different when a bank
serves a hundred of clients ( one branch), or te ns of thousands of clients in retail
banking or millions of customers (the need for infrastructure is huge).
2. Strategies used for banking expansion overseas
Depending on the strategy used for entering new markets, we can
distinguish the following strategies used for banking expansion overseas:
1) follow the client strategy, 2) lead your client overseas strategy, 3) look for a new market strategy, 4) follow your leader strategy. We have already discussed about the first strategy in the chapter about
ways of entering new markets. This is a reactive strategy. If banks do not
follow their customers abroad, the clients might establish new banking
relationships in order to replace the already existing relationships with the
domestic bank. A banking relationship cons ists of a flow of information. This
flow of information enables the bank to assess any new loan proposal at a low
marginal cost, as most of the assessme nt work has been done previously. The
lower marginal cost gives a bank’s offshore subsidiary a competitive advantage over its traditional competitors.
Following the client behavior leads to new business opportunities (take as
example the expansion of banks from Austria, Germany and Netherlans). Austrian and German banks were among the first to enter the CEE countries
and now they have a predominant numbe r of representatives. In Hungary,
Austrian banks tend to buy low-risk customers with a high volume of
transactions, such as state-owned ba nks, former monopolies (Majnoni et al.,
2003). Citibank, ING and ABN AMRO fo llow their customers in these
countries, and then, after start-up phase, they tend to develop a portfolio of
services using local customer base, e ngaging in competition with local banks.
Another reason for following customers wa s to simply make sure that the
bank had an initial position on the foreign market and then look for extension in
the near future. This expectation appro ach is pursued, for example, by Deutsche
Bank in Hungary (Majnoni et al., 2003.). Th ere are also specific factors that led
to the entry of foreign banks through me rgers and acquisitions. For example, in

Nicoleta Hurduc, Alin Ni țu
50
Poland, a number of foreign banks have agreed to take over certain Polish
banks with problems, simply to "buy" a license to operate in this market.
These actors were not interested in these banks and therefore they will not
engage effectively in rest ructuring and managing the problems of the banks. For
example, in December 1994, Westdeutsche Landesbank agreed to buy 29% of the new issue of shares of Morski Bank in exchange for a license given by the
National Bank of Poland in February 1995. A similar procedure was later
applied by other German banks. In order for them to get an operating license,
they had to either support banks faci ng difficulties or to take over bankrupt
banks (Konopielko, 1999).
While banks may merely follow their customers into foreign countries,
they may, as well, be present in foreign markets prior to their corporate clients,
pursuing the so called “leading the customer” strategy (Buch, 1997, p. 344).
Often a bank can act as an external ag ent for its domestic clients through the
newly developed contacts abroad. Esp ecially small- and medium-sized
enterprises, which are the clients of large international banks, are being helped by their bank’s expansion abroad, as they have access to information about the
external markets and are also provid ed with proper advisory services.
This fact gives the possi bility for internationally operating banks not only
to improve and enlarge thei r range of products and serv ices, but also to expand
their portfolio of clients. Small and medium enterprise s are often able to obtain
adequate detailed information on their own. Clients of banks operating abroad,
SMEs can take over trade relationsh ips with foreign companies through
information obtained from the bank. Through these services the credit institution helps the medium clients to enter new and unknown markets, and the
small clients and companies with no prio r foreign experience to expand abroad.
Such information and consultation services are known as "banking consultancy”. They help building cu stomers’ loyalty for their banks.
Search for new markets strategy means that by some reasons banks are
always looking for new international ma rkets. According to this strategy, the
bank is trying to find a new niche on th e international market. The strategy
presumes to search for better returns adju sted to some greater risks than those
present on the home market, even in uncertain circumstances. Mainly
experienced and strong inte rnational banks follow th is strategy because they
can bear greater risks. Such banks aim to achieve a global service network that
should be multicultural and in order to achieve cost and sales synergies.
“Follow your leader” strategy explains why banks chose to open branches
in other countries, even though they do not have clients there. On an
international scale, oligopolistic rivalr y leads to some typical patterns of
conflict, be it between ba nks originating from the same country or from

Forms and Strategies of the Banks to Enter on a Foreign Market
51
different countries. The scheme most often referred to in literature is
undoubtedly “follow your leader”. When a bank has an interest in a foreign
country, all its competitors tend to move in that country too, as they are all
concerned that the advantages gained by the first arrived will change the
configuration of the competitive home market (Bouteiller, Marois, 1999, p. 6). Competition in the banking sector is usually very intense, and only due to a steady development it is possible for a bank to remain competitive. This strategy is associated with lower risks than the previously mentioned strategy.
The market which was already penetrated by a competitor has an acceptable risk level and a thorough market analysis is no longer needed.
As in the general case of emerging count ries, the most important fields of
activities of the foreign banks in CEE countries are corpor ate banking, trade
finance and foreign exchange transactions . Retail activities are perceived as the
least important. The main reasons are lo w income levels of the population and
the high costs of setting up branch networ ks. However, in the second half of the
1990s, some foreign banks began to realize the potential of the retail market and
began to actively operate in this ma rket. Other corporate services that
complement the existing corporate produc ts are non-financial services (such as
consultancy), market trading services and leasing services. These services
enable banks to use their know-how and liquidity resources to generate some
extra income.
In the Czech Republic, as far as the assets structure is concerned, the
weight of credits and debt securities in the balance of foreign banks is smaller
than in the balance of large local banks . On the liabilities side, foreign banks
depend heavily on inter-bank markets, w ith a much lower level of customer
deposits in their portfolios. This emphasi zes the corporate-oriented approach of
the foreign banks. In Poland, foreign banks employ around 40% of their assets in inter-bank operations and trade finan ce. Another important differentiation of
foreign banks is their reduced weight of fi xed assets in the total assets. This is
caused by the reduced number of branches of these banks. In most cases, the
headquarters of the banks are rented and therefore they make a contribution to the operating costs. In some banks (U niCredit, ING and Société Generale)
recently involved in the development of their own office buildings, there might
be registered an increase of the weight of fixed assets in the total assets and a
decrease of operating costs.

Nicoleta Hurduc, Alin Ni țu
52

References

Aliber, R.Z., „Towards a Theory of International Banking”, Economic Review , Federal Reserve
Bank of San Francisco”, 1976, pp. 5-8
Bonin, J. P., Mizsei, K., Szekely, I. P., Wachtel, P. (1998). Banking in Transition Economies:
The Role of Foreign Banks in Economies in Transition , Bodmin, Cornwall, MPG Books
Ltd
Grubel, H., „A Theory of Multinational Banking”, Banca Nazionale del Lavoro Quarterly
Review , No. 29, 1997, pp. 349-363
Khoury, S.J., „Foreign Banks in the United States: Entry Strategies and Operations”, Advances
in International Banking and Finance , Vol. 3, 1998, pp. 152-175
Williams, B., „Positive Theories of Multinational Banking: Eclectic Theory versus
Internalisation Theory”, Journal of Economic Surveys , Vol. 11, No. 1, 1997, pp. 71-100
Williams, J., Liao, A., „The Search for Value: Cross-border Bank M&A in Emerging Markets”.
Comparative Economic Studies , 50, 2008, pp. 274-296
Rugman, A.M., Kamath, S.J., „International Di versification and Multinational Banking”, in
Recent Developments in Inter national Banking and Finance , 1987, Lexington Books
Majnoni, G., Shankar, R., Varhegyi, E., „The Dynamics of Foreign Bank Ownership – Evidence
from Hungary”, The World Bank Policy Research Working Paper Series , 3114, 2003
Mohanty, S., Nolle, D., Seth, R., „Do Banks Follow Their Customers Abroad?”, Financial
Markets, Institutions & Instruments , Vol. 7, No. 4, 1998, pp. 1-25
Bouteiller, E., Marois, B. (1999). Strategies of European Banks in Emerging Countries: A
Comparative Approach , HEC Foundation
Gray, J.M., Gray, H.P., „The Multinational Bank: A Financial MNC?”, Journal of Banking and
Finance , No. 5, 1981, pp. 33-69
Konopielko, L., „Foreign Banks’ Entry into Central and East European Markets: Motives and
Activities”, Post-Communist Economies , Vol. 11, No. 4, 1999
Dunning, J.H. (1975). The Economic Theory of Multinational Enterprise , London, Macmilan
Pomerleano, M., Vojta, G., „What Do Foreign Financial Institutions Do in Emerging
Markets?”, Open Doors: Foreign Participation in Financial Systems in Developing
Countries , 2001, Washington DC, Brookings Institution Press
Tschoegl, A.E., „International Banking Centers, Geography, and Foreign Banks”, Financial
Markets, Institutions & Instruments , Vol. 9, No. 1, 2000, pp. 7-31
Tschoegl, A.E., „Financial Crises and the Presence of Foreign Banks”, Wharton Financial
Institutions Center Working Paper , 35, 2003
Curry, E., Fung, J., Harper, I., „Multinationa l Banking: Historical, Empirical, and Case
Perspectives”, in Mullineux, A.W., Murinde, V. (ed.) Handbook of International
Banking, UK and USA, 2003, Edward Elgar
Yildirim, H.S., Philippato s, G.C., „Efficiency of Banks: Recent Evidence from the Transition
Economies of Europe, 1993-2000”, The European Journal of Finance , 13, 2007,
pp. 123-143
Root, F. (1982). Foreign market entry strategies , AMACOM, New York