Cross-border activity in the banking industry remains relatively low in the European Union (ECB, 2007). This trend is considered as problematic by European authorities as cross-border activity is viewed as a necessary condition for the implementation of the Single banking market and therefore as a positive factor for the enhancement of competition and cost performance in the European Union. This view is notably illustrated by the European Central Bank in their description of the state of financial integration in Europe: “Cross-border banks play an important role in the process of banking integration. They enhance competition in the euro area banking markets (…). In this fashion, they promote convergence towards more efficient, lower-cost banking practices.” (ECB, 2007, p.33)
However the surprising observation that emerges from the empirical literature is the impressive lack of studies on the impact of cross-border activity on the EU banking markets. A very small number of papers have compared domestic and foreign banks in terms of efficiency in these countries (e.g. Berger et al., 2000). Furthermore none has ever investigated the impact of cross-border activity on banking competition, which is the key issue, as cross-border activity is expected to exert an impact on efficiency via competition. Additionally, one important issue related with cross-border activities is the mode of bank entry. With the liberalization of financial markets foreign bank entry has become effective through two different ways: (i) by establishing foreign subsidiaries and branches (greenfield banks) or (ii) by taking over established foreign banks (takeover banks).
Since there are pronounced differences in the strategies pursued by these two type of banks the mode of entry may influence the impact of cross border activities. However few studies have addressed this issue in terms of performance and competition (see the literature review section) even we can notably point out for instance that a cross-border entry via a greenfield investment should promote more competition than by a M&A (Claeys and Hainz, 2006). This comes from the increase of the number of competitors, but also from the possible informational capture of clients by incumbent (Sharpe, 1990). Particularly, no study is found covering this issue for the case of EU banking markets.
The aim of this paper is therefore to investigate the impact of cross-border activity, depending on the mode of entry, on the conditions of the banking markets in the European Union. To this end, we use bank-level data for the 1994-2005 period. We consider three dimensions of the banking market conditions. We first investigate whether differences in terms of cost efficiency exist between categories of banks. Cost efficiency is measured with the stochastic frontier approach (e.g. Bonin, Hasan and Wachtel, 2005). We then analyze the possible differences in profitability, assessed with the return-on-assets. Finally, we study whether categories of banks differ according to the Lerner index, which is an inverse measure of competition. This latter measure has been recently used in several works to measure bank competition on the markets (e.g. Martin, Salas and Saurina, 2006). It however constitutes a great innovation of our paper, as no former paper has ever performed a micro-level analysis of the impact of foreign bank presence on competition.
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How Does Cross-Border Activity Affect the EU Banking Markets?
