South-South foreign bank entry

Banks from London and New York are not the only players getting into developing country banking markets. A little-known fact is that banks from 48 developing countries have already invested in the banking sector of other developing countries. Good news, because these banks are well-suited to offer inclusive financial services to the poor.

In a recent paper on Foreign banking in developing countries, Neeltje van Horen shows that 27% of foreign banks in developing countries are owned by a bank from another developing country. She finds the South-South foreign banking trend to be especially pronounced in low-income countries.

Although foreign bank entry by both developing country as well as high-income country banks seems to be driven by economic integration, common language and proximity, banks from developing countries are more likely to invest in small developing countries with weak institutions where high-income country banks are reluctant to go. This result seems to suggest that developing country banks have a competitive advantage dealing with countries with a weak institutional climate.

In the companion paper Location decisions of foreign banks and competitive advantage, Stijn Claessens and van Horen draw the conclusion that banks consider their comparative advantage in handling weak institutional quality when moving into new markets.

Our results suggest that it is not the level of institutional quality per se or the similarities in institutional quality between host and source country that have a determining impact on the location decision, but rather that similarities in institutions between host and source country as compared to the bank’s competitors determine entry decisions.