A number of theories have been proposed as to why banks should expand internationally, although all of these, ultimately, relate to banks’ ability to earn profits from doing so. Major theories to explain international expansion include the industrial organization theory, the comparative advantage theory, the international investment theory, portfolio theory, the internalisation theory and the eclectic theory.
The industrial organisation theory has a number of different strands, including banks following their customers into foreign markets, higher concentration in the home country market providing higher profits to support expansion, greater strength or importance of the home country currency and a desire to secure (retail) deposits in the host country. The comparative advantage theory proposes that banks expand from countries with a comparative advantage in the supply of banking services. International investment theory is based on the idea that banks will expand internationally in order to exploit or avoid market externalities, while portfolio theory argues that international expansion is a risk diversification decision. Internalisation theory recognises the market imperfections preventing the efficient operation of international banking, and suggests that a bank expands internationally to overcome externalities. The eclectic theory combines a number of strands, largely from the internalisation theories: these are ownership-specific advantages, internalisation specific advantages and location-specific variables.
Within this range of options, relatively little attention has been given to portfolio theory, which could be used to argue that banks ought to expand internationally to reduce the risks of investing solely in their home markets. Grosse and Goldberg (1991) found that banks from countries considered risky were more likely to have a foreign office, but an alternative perspective has been that countries can diversify their loan portfolios internationally without an extensive network of foreign offices (although a bank’s lending portfolio might then be limited to low-margin, wholesale business). Other studies have considered exchange rates as a factor in banks’ foreign investment decisions, but the focus of these has often been on the issue of whether an investment is likely to generate a foreign exchange gain or a loss (e.g. Hultman and McGee, 1989; Moshirian and Pham, 1999; Moshirian, 2001). Relatively little attention has been given to looking at internationally active banks’ assets as a portfolio, with sub-portfolios in different countries exposed to different risks and returns.
This paper attempts to fill some of the gap in the exploration of the portfolio theory of the international expansion of banks by looking at the four major Australian banks, each of which has significant operations outside Australia. The specific focus is on the impact of changes in the exchange rate of the Australian dollar relative to the currencies applying to the main countries into which these major Australian banks have expanded their operations. The effect is measured in terms of the effect on stock returns for those Australian banks; the sample period is from 1 Jan 1997 to 31 March 2007 and the methodology employed is the capital market method. Surprisingly, we find no significant foreign exchange impact on the four major Australian banks’ stock returns, or on the stock returns of the five Australian regional banks. Questions are then raised as to the efficiency of stock markets in recognising banks’ foreign exchange exposures arising from their overseas assets and business.
The rest of the paper is structured as follows. The next section provides some detail on the international operations of the major Australian banks and their history. The third section outlines the key hypothesis that will be explored in this study, while section 4 introduces the data that are used for the analysis. Section 5 reports and reviews the results and discusses their implications, while section 6 concludes and identifies issues for further research.
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