The Implementation of Multinational Banks in Emerging Countries Finance Essay

Profit opportunities are related to the characteristics of the country of origin and those of the host country. Foreign banks seize the opportunities that arise in emerging countries. They are attracted by attractive tax regulations and a lower level of taxation, by high prospects of economic growth and efficiency, and the existence of an uncompetitive banking sector. The competitive situation in the host country is an important factor in the choice of location. It is essential for multinational banks to examine the competitiveness of local banks, opportunities to enter the market and the probability of winning a market share. For example, the interest of Spanish banks for the banking market in Latin America can be explained by the low banking penetration in the region. The demographic structure of the host country is also an important factor to consider in choosing the host country. According to the theory of life cycle, savings allow the individual to ensure consumption in the future. In his early active life, the individual tends to borrow. Thus, young adults have negative savings. Afterward, the individual can save (accumulation phase). In retirement, he uses his savings (negative savings). Economies with young populations represent an attractive market for banks operating retail services. Indeed, even if these banks do not record gains in the short term, they can make a profit when people come to the accumulation phase. These banks generally have a long-term strategy. They are therefore aiming at a positioning on the market at a moment where the savings of most individuals is negative hoping for a future return or yield (Smith & Walter [2003]). The demographic structure of emerging regions is characterized by a young population, which would - in the long term - constitute the future customers of retail banking. Demographic growth prospects in emerging markets are particularly attractive for European banks. Indeed, population projections preview a reduction of the European population in 2050. With regard to tax regulations, banks take into account mainly the corporate income tax, taxes on banking products and the existence of agreements to avoid double taxation between the country of origin and the host country.

Table 1: Population projections 2050 (in millions of individuals)

2010

2050

Africa

1033 1937

Asia

4166 5217

Europe

730 653

Latin America

593 783

North America

348 483

World

6906

9076

Source: World Bank, United Nations Claessens et al. [2001] support the hypothesis that high taxes strongly discourage the entry of foreign banks. Multinational banks dependent on the ability of the host country to ensure liquidity and monetary stability, are brought to focus on other macroeconomic factors such as the stability of the currency, moderate inflation and relatively low interest rates, etc. The existence of effective communications systems also plays a crucial role in the selection of an optimal location. Indeed, the quality and availability of these systems are necessary for the proper functioning of banks. In addition, the location (near economic centers) can be a decisive factor in the location. It is also important to consider the conditions on the labor market, particularly the availability of skilled labor, labor costs and labor laws. The problem of qualifications must be taken into consideration because the costs of learning and training can be significant barriers to the development of multinational banking activities. Restrictive regulations of the host country reduce investment opportunities and available choices. Some of these regulations limit competition and protect inefficient domestic banks. Foreign banks therefore have a preference for countries with open banking systems (Miller & Parkhe [1998]). To attract foreign banks, governments have an incentive to impose low regulatory costs such as low taxes and limited entry barriers. Political stability is also a decisive factor for the choice of location as it determines the economic and legal conditions in the country. Multinational banks should also take into account the country risk, which is measured by indicators such as the deficit of the balance of payments, inflation, GDP growth and debt service. Finally, the regulations of the country of origin may affect the banks' expansion abroad. Restrictions on FDI outflows reduce the likelihood that banks locate in other countries.

3.3 The impact of Basel II on the implementation of multinational banks in emerging countries

The Basel accord aiming at improving the financial system's solidity applies to all international banks. The new capital requirements are more consistent with the risks to which banks are exposed. They are now required for credit risks, market risks and operational risks. The implementation of this agreement will have consequences not only on banking activities but also on the internationalization strategies of banks. The latter should reflect the Basel II requirements before taking decision on the establishment abroad, especially in emerging countries. By substantially modifying the calculation of the cost of risk, the Basel II changes in depth the strategies for the allocation of credit, pricing, measurement and management of risks. Will multinational banks tend to reduce their investments in these countries as they would be forced to hold more capital to cope with higher risks? Or rather, they will enjoy the potential competitive advantage over local banks that may have difficulties to meet the requirements of Basel II?

3.3.1 From Basel I to Basel II

Compared to Basel I which is solely based on quantitative equity requirement calculated according to a standard method, the new agreement includes a number of innovations. The new capital requirements take into account credit risk, market risk as well as operational risks. The new capital ratio further integrates the reality of risks. For the calculation of minimum capital requirements, banks have the choice between using standard methods and methods based on internal ratings IRB. The Basel II rests on three pillars: Pillar I: "capital requirements" Pillar II: "Prudential Supervisory Process": supervisory authorities may impose individual requirements higher than those calculated by the methods proposed by the first pillar. Pillar III: "Market Discipline": Banking institutions are required to publish comprehensive information on the nature, volume and methods of managing their risks and the adequacy of their capital. The new Basel agreement increases the capital requirements of banks operating in emerging countries. The implementation of Basel II by the industrialized countries has consequences not only on the location decisions of multinational banks in emerging markets but can also cause changes in strategy for banks with already established subsidiaries and branches in these countries. The loans granted by foreign banks in emerging countries for sovereign borrowers as well as for banks and enterprises in the host country are now subject to the new Basel II. Multinational banks should take account of new capital requirements particularly with regard to credit risk. As part of the revised standard approach, the calculation of credit risk is more differentiated in function of risk. The major change, compared to Basel I guidelines, concern borrowers rated B and below. The weighting of credit risk in this category increased from 100% to 150%.

Table 2: Weights applicable to different categories of borrowers

Basel I

Basel II

Rating

AAA to AA- A+ to A- BBB+ to BBB- BB+ to BB- B+ to B- Less than B- Unrated

States

OECD 0% 0% 20% 50% 100% 100% 150% 100% Non-OECD 100%

Banks

20% 20% 50% 100% 100% 100% 150% 100%

Companies

100% 20% 50% 100% 100% 150% 150% 100%

Individuals

100% 75%

Mortgage

50% 40% The new Basel Accord requires the weighting of the highest risk to 150% particularly: the claims on sovereigns, other public sector entities, banks and investment firms rated less than B-; the claims on companies rated less than BB-, the unpaid claims for more than 90 days and receivables deemed particularly risky by the national supervisory authority. Emerging countries as well as local companies and banks, often with low ratings, represent a quite high credit risk which implies higher cost of capital for these regions. On the other hand, countries that have better ratings benefit from the provided system in the framework of the Basel II since that regulatory changes aim in particular to a more efficient allocation of credit taking into account the different levels of borrowers' risks. The difference between the minimum capital requirements for banks located in different countries can be considerable; this could influence the choice of the latter with respect to the host country to be chosen for their internationalization. The adoption of the IRB approach significantly increases the weighting of low rated borrowers thus generating a significant increase in the minimum capital required. Thus, banks having adopted the IRB approach would be encouraged to give loans to the best borrowers, usually located in countries with a high rating. It would be more advantageous for multinational banks to locate in these countries; especially that the new agreement encourages banks to retain the IRB approach.

3.3.2 The New Basel Accord enhances the competitive advantages of foreign banks

Emerging countries have no obligation to apply the provisions of the new Basel Accord, however, they are strongly encouraged to do so. In fact, emerging countries do not have much choice. Not applying the international monitoring standards could put them away from the international financial community. In addition, the loans granted by the IMF or the World Bank are often subject to conditions on the compliance of local regulations with international standards. Similarly, the establishment of branches in a foreign country is allowed only if the country of origin shall apply the Basel Accords (Mark [2003]). On the other hand, the development of standards specific to emerging countries is very expensive for those countries that lack the resources and expertise to tackle such a project. Thus, regulators in emerging countries are more or less forced to apply the Basel Accord requirements, even if they are not adapted to the contexts of these countries. The implementation of Basel II in emerging markets could have a negative impact on local banks; these could be in a competitive disadvantage. Indeed, the Basel Accords, being basically established for the large multinational banks in order to limit bank risks, are not really suited to the needs and conditions of the banking system in emerging countries. The prudential regulations adopted under the new agreement may be inappropriate and may even weaken the banking system in emerging countries (Rojas-Suarez [2001]). On the other hand, the large international banks often retain the IRB approach, an approach that is difficult to apply in developing countries. This approach generally requires a lower level of capital than that required by the standard approach thus strengthening the competitive position of international banks relative to domestic banks in emerging countries (Mark [2003]). Indeed, foreign banks tend to attract less risky customers who benefit from a less strong risk weight in the case of an IRB approach than in the standard approach. The competitive advantage that multinational banks could benefit from with the implementation of Basel II requirements should encourage them to locate in emerging countries. Foreign banks may take control of some weakened local banks and even dominate the banking system in these countries.

Chapter 4:

Intervention strategy

4.1 Framework

The suggested intervention consists of reaching a higher level of internationalization for Credit Libanais, and a bigger diversification for EFG Hermes Group's activity. Concretely, the intervention would be the inauguration of Credit Libanais in the countries of the West African Economic and Monetary Union. Since that penetrating new markets tend to be a considerable investment, it would be more appropriate to choose one country among those targeted ones to start the internationalization operation. Consequently, it is suggested to start with the Ivory Coast. The following sections aim at explaining or justifying this choice, thus highlighting the importance of this intervention.

4.2 Ivory Coast's Economic Prospects

The economic and social prospects for Cote d'Ivoire depend largely on the pacification of the country and the successful implementation of emergency reconstruction programs. Thus, assuming that the security situation is normalized in the second half of 2011, in conjunction with the lifting of sanctions and resumption of international cooperation, a strong recovery in GDP growth in real terms (about 6%) is expected as from 2012. On-going efforts to ensure the supply of petroleum products, secure production areas and rehabilitate marketing channels should push inflation down to less than 3% as from 2012, that is to say below the WAEMU convergence criteria. The return to political stability has fuelled great expectations among the population regarding the delivery of essential public services and rapid improvement in living standards. However, this will mean a major risk in terms of unfulfilled social demands. The redeployment of the tax and customs administration in the CNW areas will help to reduce tax evasion and consequently improve the collection of revenue necessary to meet increased spending prompted by the pressing needs of the population. The commitment of development partners to support the Ivorian authorities in their reconciliation and reconstruction efforts will create an atmosphere of confidence conducive to renewed growth and private sector development. Given the constant interaction between the Ivorian economy and that of neighboring WAEMU countries and particularly the movement of people, any support to Cote d'Ivoire will have direct or indirect spill-over effects at the regional level on the hinterland countries. IMF projections in September 2010 suggested improved economic growth of about 4.8% for the 2012-2014 period, stabilizing at 6% thereafter and reaching the historical post-devaluation growth path (1994-1998). The Ivorian economy could experience fast recovery because there was no excessive destruction of capital. In the medium and long term, growth will mainly depend on: (i) rehabilitating public infrastructure; (ii) improving governance, particularly in public and semi-public enterprises, as well as in the coffee/cocoa, energy and financial sectors; and (iii) improving the business environment.

4.3 Ivory Coast Economic Outlook

The Ivory Coast economy is heavily dependent on agriculture and related activities, which engage roughly 68% of the population. As the world's largest producer and exporter of cocoa beans and a significant producer and exporter of coffee and palm oil, the economy is highly sensitive to fluctuations in international prices for these products. The considerable political turmoil in the last decade has continued to damage the economy, leading to decreased foreign investment and weak economic growth, as can be seen below. Source: Drum Commodities, Ivory Coast Report, March 2012. The political chaos weighed heavily on the economy in 2011, with GDP falling to -7.3% after moderate growth in 2010 and now little higher than the 1999 level. With the return of stability, the IMF has forecast growth of 5.9% for 2012, with large injections of aid last year geared towards reconstruction helping to kick-start activity. Cocoa output is in the process of recovery and there are hopes of renewed inflows of investment in other sectors. Sustained growth will require large amounts of aid and renewed inflows of FDI, which will be helped by the new $615m IMF loan approved in November 2011. This loan was granted under the Extended Credit Facility (ECF), which has a zero interest rate, a grace period of 5.5 years, and a final maturity of 10 years. Debt relief is a high priority; 40% of 2012 budget spending is on debt service, and repayments on a $2.3bn eurobond have been in default for the past year. 2009 2010 2011 2012 (projected) Real GDP Growth 3.7 2 -7.3 5.9 CPI Inflation 4.7 2.7 6.3 3.3 Budget Balance % GDP -1.6 -2.5 -1.9 -3.4 Current Account % GDP 7.2 5.9 5.2 4.2 Source: Drum Commodities, Ivory Coast Report, March 2012.

4.4 Ivory Coast's tertiary sector

The tertiary sector of the economy continues to play a key role in the Ivorian economy. It proved to be the driving force behind the economic growth of 2010 as crop production fell, with particularly strong performances from the telecommunication, commerce and services sector. As expected though, this suffered in the 2011 crisis, particularly the tourism and hotel industry, but expectations are that this sector will help propel the economy's recovery in 2012. Table Showing Composition By Sector as a Percentage of GDP:

Composition

% of GDP

Agriculture 29.2 Services 49.8 Industry 20.9 Other 0.1 Source: Drum Commodities, Ivory Coast Report, March 2012. Ivory Coast's banking system is playing an increasing role in financing the different sectors of the national economy. It provided the primary sector with XOF 57.2 billion (4% of total financing), the secondary sector with XOF 556.5 billion (37% of total financing) and the tertiary sector with XOF 876.6 billion (69% of total financing). There are 5 banks with majority Ivorian capital functioning: Banque nationale d'investissement (BNI), Banque pour le financement de l'agriculture (BFA), Banque pour l'habitat de Côte d'Ivoire (BHCI), Versus Bank, and CNCE. Soci©t© g©n©rale de banque en Côte d'Ivoire (SGBCI) and Banque Internationale pour le commerce et l'industrie de Côte d'Ivoire (BICICI), which are subsidiaries of the French banks Soci©t© g©n©rale and BNP Paribas, between them cover the wage bill of 80 600 civil servants and other state employees and account for close to 30% of the Ivorian banking market. Monetary policy is implemented at regional level, as Ivory Coast and the other member states of WAEMU share currency, the CFA Franc (XOF), which is pegged to the Euro at a fixed parity. Monetary and credit policy is run by the Central Bank of West African States (BCEAO), which has close links to the French Treasury as part of the monetary co-operation agreement between France and WAEMU member countries. The Dollar/West African CAF Franc Exchange Rate is: USD/XOF rate: $1=XOF498 The country's recent macroeconomic policy has been to pursue the implementation of the 2009-11 financial and economic program and the Poverty Reduction Strategy Paper (PRSP), in order to complete the Highly Indebted Poor Countries (HIPC) initiative. Ivory Coast is one of the 40 countries worldwide eligible for this, considered to face an unsustainable debt burden that cannot be managed by traditional means. This grants the recipient country debt relief or low-interest loans to cancel or reduce external debt repayments to sustainable levels. The success of the economic reforms above has led to the Paris Club of international creditors rescheduling Côte d'Ivoire's debt. This will reduce repayments by more than 78% over the next three years; roughly US$1.9bn was deferred and US$400m was cancelled. There has been marked progress in Ivory Coast's economic partnerships with other emerging economies. Co-operation is often based on sharing experience and knowledge, the transfer of technologies and access to their respective markets. The country's natural resources and its position within the WAEMU and ECOWAS economic zones render it ideal for partnership with other emerging economies. Ivory Coast's increasing connection with emerging economies has served to lessen the dependence on its traditional trading partners, namely Europe. Despite this, the EU still dominates Ivory Coast's foreign trade, but this trend is lessening, particularly with regard to Ivorian imports.

4.4.1 Domestic credit provided by the banking sector

Domestic credit provided by the banking sector includes all credit to various sectors on a gross basis, with the exception of credit to the central government, which is net. The banking sector includes monetary authorities and deposit money banks, as well as other banking institutions where data are available (including institutions that do not accept transferable deposits but do incur such liabilities as time and savings deposits). Examples of other banking institutions are savings and mortgage loan institutions and building and loan associations. Domestic credit provided by banking sector (% of GDP) in Côte d'Ivoire was 25.14 as of 2010. The Domestic credit provided by banking sector (% of GDP) in Cote d'Ivoire was last reported at 25.31 in 2011, according to a World Bank report published in 2012. Its highest value over the past 48 years was 51.26 in 1983, while its lowest value was 16.22 in 1963. Source: World Bank Indicators, 2012.

4.4.2 Commercial banks and other lending (PPG + PNG) (NFL; US dollar) in Cote d'Ivoire

The Commercial banks and other lending (PPG + PNG) (NFL; US dollar) in Cote d'Ivoire was last reported at -58213000 in 2010, according to a World Bank report published in 2012. Commercial bank and other lending includes net commercial bank lending (public and publicly guaranteed and private nonguaranteed) and other private credits. Data are in current U.S. dollars. Source: World Bank Indicators, 2012.

4.4.3 Cost of business start-up procedures (% of GNI per capita) in Cote d'Ivoire

The Cost of business start-up procedures (% of GNI per capita) in Cote d'Ivoire was last reported at 132.60 in 2011, according to a World Bank report published in 2012. Cost to register a business is normalized by presenting it as a percentage of gross national income (GNI) per capita. Source: World Bank Indicators, 2012.

4.4.4 CPIA financial sector rating (1=low to 6=high) in Cote d'Ivoire

The CPIA financial sector rating (1=low to 6=high) in Cote d'Ivoire was last reported at 3 in 2011, according to a World Bank report published in 2012. Financial sector assesses the structure of the financial sector and the policies and regulations that affect it. Source: World Bank Indicators, 2012.

4.4.5 Deposit interest rate (%) in Cote d'Ivoire

The Deposit interest rate (%) in Cote d'Ivoire was last reported at 3.50 in 2010, according to a World Bank report published in 2012. Deposit interest rate is the rate paid by commercial or similar banks for demand, time, or savings deposits. Source: World Bank Indicators, 2012.

4.4.6 Foreign direct investment; net (BoP; US dollar) in Cote d'Ivoire

The Foreign direct investment; net (BoP; US dollar) in Cote d'Ivoire was 380872959.97 in 2009, according to a World Bank report, published in 2010. Foreign direct investment is net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. This series shows total net, that is, net FDI in the reporting economy from foreign sources less net FDI by the reporting economy to the rest of the world. Data are in current U.S. dollars. Source: World Bank Indicators, 2012.

4.4.7 Bank liquid reserves to bank assets ratio (%) in Cote d'Ivoire

The Bank liquid reserves to bank assets ratio (%) in Cote d'Ivoire was reported at 9.45 in 2008, according to the World Bank. Ratio of bank liquid reserves to bank assets is the ratio of domestic currency holdings and deposits with the monetary authorities to claims on other governments, nonfinancial public enterprises, the private sector, and other banking institutions. Source: World Bank Indicators, 2012.

4.5 Ivory Coast Export/ Import Commodities

Ivory Coast's main export commodities are cocoa, coffee, timber, petroleum, cotton, bananas, pineapples, palm oil and fish. Its primary imports are fuel, capital equipment and foodstuffs. Ivory Coast's primary export trading partners are US (10.2%), Netherlands (10%), Nigeria (7.7%), Ghana (6.7%), Germany (6.2%), France (6.2%) and Burkina Faso (4.5%). The country's main import partners are Nigeria (22.4%), France (12.6%), China (7.1%) and Thailand (4.8%) (2010). Total exports for the year 2011 came to $11.24 billion, whilst imports totaled $7.295 billion. Europe remains the country's largest continental trading partner with 44% of trade, ahead of the rest of Africa with 29% and Asia with 12.5%. China's share of 3.2% is modest by comparison with its position in Africa generally, but is growing rapidly, driven by cheap Chinese exports. Trade with other emerging countries such as Brazil, Malaysia and India have also developed in recent years, as too has their investment in Ivory Coast.

Chapter 5:

Conclusion

The decision of M&A operation between Credit Libanais and EFG Hermes was made on strategic basis. The Credit Libanais' objective is to achieve geographical expansion using its acquirer financial power and EFG Hermes' objective is to achieve an enhanced business diversification especially after it sold its shares in Audi Bank. In general, EFG Hermes has reached its objective the moment the M&A operation was executed. On the other hand, Credit Libanais' objective is still not reached. Benefiting from the points of strength and the present opportunities, an intervention is suggested in this paper for Credit Libanais in order to overcome its weaknesses and threats. The intervention consists of penetrating a new market which is the West African Economic and Monetary Union market. It suggests the opening of Credit Libanais in the Ivory Coast which is a member of the WAEMU. This location was chosen for the growing importance of the Ivory Coast economy within the WAEMU and for many other encouraging factors such as the country's tertiary sector, banking structure, and cost of business start-up procedures as well as the presence of an important Lebanese community there. This paper has detailed the Credit Libanais' environmental factors and suggested an intervention for a better performance and strategic implementation. It didn't go through cost details since that information concerning location price, equipment price and availability, and wages and salaries in Ivory Coast are difficult to get. Moreover, the cost issue of the intervention is not the primary factor for the implementation decision making since that this intervention is a first step in a series of market implementation targeting the rest of the countries of the WAEMU. In other words, it's an investment that is expected to generate revenues on the medium and long term rather than the short term and comes to satisfy the M&A bank's objectives.

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