The global financial crisis and subsequent sovereign debt crisis have left many banks in advanced economies teetering on the brink of collapse. In emerging markets, on the other hand, banks have not only weathered the storm, but even thrived — many emerging market banks have vaulted up the global size rankings, according to the Financial Development Report 2012, released by the World Economic Forum last week.
China’s ICBC is the world’s biggest bank in terms of market value, and seven additional emerging market banks from China, Brazil and Russia are among the top 25 banking financial institutions. This impressive rise is further validated by the fact that, as recently as 2005, no emerging market bank was in the list of top 25 largest institutions by market capitalisation.
The expansion of emerging market banks has not been confined to domestic markets. Rather, emerging market investment in foreign banks has grown, in terms of both number of host countries and number of investors. From 1995 to 2009, the number of emerging markets that pursued banking activities in other countries increased from 45 to 60. Low-income countries are the primary investment locale for emerging market banks, and as of 2009, South Africa, Russia, Turkey, and Brazil were the most active investors, owning 31, 29, 21, and 17 foreign banks, respectively.
Whereas banks from advanced economies continue to seek expansion opportunities at the global level, emerging market banks tend to invest in smaller, less-developed countries within their own region. In fact, 80 per cent of investments from emerging market banks are within their own region. This regional effect may be due to the competitive advantage that emerging market banks have in working in institutionally weak and politically tumultuous environments.
Although the recent financial turmoil has put the global banking system in an increasingly precarious position, emerging market banks find themselves poised to capitalise on this uncertain environment. Domestically, emerging market banks will benefit from a large unbanked population, as well as the strong credit demand that is needed to finance economic growth.
Banks from emerging markets are also expected to play a more active role as foreign investors, particularly within their own geographical regions. The expansion of emerging market banks at both the domestic and regional levels will likely represent a considerable shift as banks from advanced economies are forced to make structural adjustments in order to adhere to the rules imposed by international and domestic regulators.
Banks engage in foreign investment for several reasons. First, foreign investment provides a possibility for risk diversification. Second, entering new markets can increase the bank’s client base. Third, by following their international customers in order to provide them with financial services, banks can exploit informational advantages derived from long-term bank-client relationships. Indeed, a number of studies have shown that foreign direct investment in banking is correlated with economic integration, as measured by trade and FDI flows between the home country of the parent and the host country in which it is investing, and with proximity, measured along several dimensions. Fourth, foreign banks tend to be attracted to countries where expected profits are higher, owing to higher expected economic growth and the existence of local bank inefficiencies.
However, research suggests that emerging market banks are more likely to invest in developing countries with weak institutions, where advanced country banks are reluctant to go — perhaps emerging market banks have a competitive advantage in dealing with such countries.
