Local Banking Sector Research Articles

Impact of financial liberalization and foreign bank entry on Islamic banking performance

PurposeThis paper aims to examine the impact of financial liberalization and foreign Islamic bank entry on the performance of domestic Islamic banks, and credit availability to the private sector.Design/methodology/approachThe authors use the weighted least squares method to estimate four models. These models are suggested by Lee. For this, the inverse of the number of domestic Islamic banks in each period is used to weight the observations in the regressions to correct for varying number of bank observations in each country.FindingsThe results indicate that foreign Islamic banks, on average, follow aggressive financing in host countries and enjoy higher net profit margin. Banking sector returns play an important role in the entry decision and presence of foreign banks. Moreover, favorable macro‐economic conditions play a supportive role while higher tax policies play a hostile role for the entry and presence of foreign Islamic banks. The recent financial crisis does not seem to affect the entry decision significantly. But the profitability of domestic Islamic banks has been seriously affected by the recent crisis. Also domestic tax policy and macro‐economic environment play important roles in determining the domestic Islamic bank performance. Results also indicate that private sector credit availability seems to suffer because of higher tax and reserve rate.Practical implicationsThe authors' findings suggest that host Islamic economies should strive for an efficient capital market with supportive macro‐economic environment, which in turn helps the local banking sector to develop and benefit from the foreign Islamic bank entry.Originality/valueThis is the first paper to analyze the entry of foreign Islamic banks in the host countries with Islamic banking sector.

Local financial development and growth

Using unique, district-level, economic growth data, I investigate the connection between banking sector development, human capital, and economic growth in Indian districts. Disaggregate data helps avoid many of the omitted variable problems that plague similar cross-country studies. The data show districts to be financially constrained by the lack of local banking sector development, and the relationship may be non-linear. For districts in the sample, moving from the 75th percentile of credit/net domestic product to the 25th percentile implies an average loss of 4% in growth over the 1990s decade. The data also shows that human capital deepening can reduce the financial constraint. In a district at the 25th literacy percentile, the implied growth loss due to a constrained banking sector is twice as large as in a district at the 75th literacy percentile. The results are robust to the inclusion of various controls and changes in specification.

Local Governments' Fiscal Balance, Privatization, and Banking Sector Reform in Transition Countries

Several transition economies have undertaken fiscal decentralization reforms over the past two decades along with liberalization, privatization, and stabilization reforms. Theory predicts that decentralization may aggravate fiscal imbalances, unless the right incentives are in place to promote fiscal discipline. This paper uses a panel of 20 transition countries over 19 years to address a central question of fact: Did privatization help to promote local governments’ fiscal discipline? The answer is clearly ‘no’ for privatization considered in isolation. However, privatization and subnational fiscal autonomy along with reforms to the banking system - restraining access to soft financing - may prove effective at improving fiscal balances among local governments.

Sovereign Credit Risk and Banking Crises

This paper develops a structural model for the valuation of sovereign debt in which a sovereign country faces a strategic default decision under the risk of experiencing a banking crisis. The sovereign's default policy is governed by the trade-off between lower debt-servicing expenditures and the costs of sovereign default represented by increased financial stress for the local banking sector. The framework developed in this paper yields new insights into the interaction between sovereign credit risk and a country's financial system. In particular, the model suggests that a large financial sector affects sovereign risk in two ways. On the one hand, it raises sovereign risk by increasing the potential losses in the event of a banking crisis. On the other hand, it lowers sovereign credit risk by committing the sovereign to servicing its debt in the future. Which effect dominates depends on variables such as size of the banking sector within the sovereign's economy, aggregate financial sector credit risk, and holdings of government bonds by domestic banks.

Do remittances promote financial development?

Workers' remittances to developing countries have become the second largest type of flows after foreign direct investment. This paper uses data on remittance flows to 109 developing countries during 1975–2007 to study the link between remittances and financial sector development. In particular, we examine the association between remittances and the aggregate level of deposits and credit intermediated by the local banking sector. This is an important question considering the extensive literature that has documented the growth-enhancing and poverty-reducing effects of financial development. We provide evidence of a positive, significant, and robust link between remittances and financial development in developing countries.

Foreign investments in China's local banking sector – the Australian experience

This article investigates the experience of Australian banks who invested in China's city commercial banks. Special emphasis is paid to corporate governance before and after they invested in the Chinese banks. Interviews were conducted with senior personnel from the ANZ (Australia and New Zealand) Banking Group who invested in the Tianjin City Commercial Bank and the Shanghai Rural Commercial Bank and the Commonwealth Bank of Australia who invested in the Hangzhou City Commercial Bank and the Jinan City Commercial bank. Our investigations showed that corporate governance in the Chinese city commercial banks was minimal before the Australian banks invested. Since then, there have been substantial improvements but differences still persist. The article also outlines the steps and strategies adopted by the two banks to improve corporate governance.

Foreign banks, exchange controls and the future of the four pillars bank policy in South Africa*

The re-entry of the British banking group Barclays into South Africa via the takeover of Absa Bank in 2005 created a new dispensation for South African banking, while strengthening the role of foreign banks in the local banking sector. It may also lead to some rerating of the local banking industry because large foreign banks operating in this country can most probably count on support from both their parent owner banks as well as the Reserve Bank if a systemic risk to the banking system emerges.

A Leading Indicator Model of Banking Distress - Developing an Early Warning System for Hong Hong and Other EMEAP Economies

This study develops a probit econometric model to identify a set of leading indicators of banking distress and estimate banking distress probability for Hong Kong and other EMEAP economies. Macroeconomic fundamentals, currency crisis vulnerability, credit risk of banks and companies, asset price bubbles, credit growth, and the occurrence of distress of other economies in the region are found to be important leading indicators of banking distress in the home economy. The predictive power of the model is reasonably good. A case study of Hong Kong based on the latest estimate of banking distress probability and stress testing results shows that currently the banking sector in Hong Kong is healthy and should be able to withstand well certain possible adverse shocks. Under some extreme shocks originating from real GDP growth and property prices such as those that occurred during the Asian financial crisis, the model indicates a non-negligible risk of an occurrence of banking distress in Hong Kong. However, the chances of the occurrence of such severe events are extremely low. Simulation results also suggest that compared to the period before the Asian financial crisis, the local banking sector is currently more capable of withstan ding shocks similar to those that occurred during that crisis. The study also finds that banking distress is contagious, suggesting that to be effective in monitoring banking distress, close cooperation between central banks should be in place.

Crises as Opportunities to Consolidate Reforms: The 1997 Financial Crisis and Banking Policy Reform in Malaysia and the Philippines

Looking at crisis responses in the Philippines and Malaysia, this paper will analyse how state-based banking policy elites in both states used the 1997–2000 crisis to radically accelerate pre-crisis policy directions that were opposed by local banking institutions and their peak associations. Drawing on empirical evidence and policy reform theory, the paper will detail how these elites used both their ability to define the nature of the 1997–2000 crisis and the appropriate responses, and their control of the executive to accelerate these directions and minimize the voice of local banking players. In the case of Malaysia, the banking policy direction to be analyzed will be banking sector consolidation, while for the Philippines it will be foreign entry and equity participation in the local banking sector. Moving away from the singular domestic focus of much policy reform literature, this paper will attempt to develop a two-level model for these crisis-driven policy accelerations. To do this, it will look at the use by these state elites of their relationships with the IMF and their banking policy obligations of the GATS as the rationale for acceleration and as the rationale for their overriding of local banking interests. This incorporation of external actors and changes to the international political economy should allow for a more nuanced and well-rounded understanding of these specific elements of the 1997–2000 crisis response, as well as the political economy of policy reform in general for both Malaysia and the Philippines.