Cross-border banking and foreign branch regulation in Europe

Published date13 May 2021
Date13 May 2021
AuthorLucia Gibilaro,Gianluca Mattarocci
Cross-border banking and foreign
branch regulation in Europe
Lucia Gibilaro
Department of Law, Economics, Politics and Modern languages,
Lumsa University, Rome, Italy, and
Gianluca Mattarocci
Department of Management and Law,
University of Rome Tor Vergata, Rome, Italy
Purpose This paper aims to examine the relevance of cross-border activity in the European banking sec tor,
evaluating the role of differences in regulation to explain the level of interest in entering foreign markets.
Design/methodology/approach The sample considers all banks in the European Union (EU 28)
existing at year-end2017, and information about the ultimate ownersnationality to classify localand foreign
banks is collected.The analysis provides a mapping of regulatoryrestrictions for foreign banks and evaluates
how they impactthe role of foreign players in the deposit and lending markets.
Findings Results show that the lower are the capitaladequacy requirements, the higher are the amounts
of loans and deposits offered by non-European Economic Area banks and, additionally, the higher the
probabilityof having a foreign bank operating in thecountry.
Originality/value This paper provides new evidence on regulatory arbitrage opportunities in the EU
and outlinesdifferences among EU countries not previously studied.
Keywords Loans, Foreign banks, Deposits, Regulatory arbitrage, Capital requirements
Paper type Research paper
1. Introduction
Any entity can engage in the business of a credit institution through a stand-alone company or a
subsidiary of a company by undergoing an authorization procedure, whereas banks that want to
expand abroad with a physical presence to develop new relationships (Rajan, 1998) can establish
themselves through foreign branches (Goldberg and Saunders, 1981). A bank branch is a not an
independent entity sharing liabilities with the home bank because the relevant processes use
internal inputs even though the branch is located in a different country (Calzol ari, 2001). Bank
branching affects nancial intermediation in local markets (Hannan and Prager, 2004)andit
fosters growth, although results are inuenced by existing conditions (Huang, 2008). Going
© Lucia Gibilaro and Gianluca Mattarocci. Published by Emerald Publishing Limited. This article is
published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce,
distribute, translate and create derivative works of this article (for both commercial and non-
commercial purposes), subject to full attribution to the original publication and authors. The full
terms of this licence maybe seen at
Authors are grateful to the editor, the two anonymous referees and all participants to the EFMA
2019 annual meeting for all the useful suggestions for revising and improving the previous drafts of
the paper. The article is the results of authorscombined eorts and continuous exchange of idea. The
introduction and literature review has to be ascribed to Lucia Gibilaro and all other sections to
Gianluca Mattarocci.
Received13 August 2020
Revised30 December 2020
Accepted21 January 2021
Journalof Financial Regulation
Vol.29 No. 3, 2021
pp. 280-296
EmeraldPublishing Limited
DOI 10.1108/JFRC-08-2020-0072
The current issue and full text archive of this journal is available on Emerald Insight at:
abroad through establishing foreign branches can be motivated by the need to satisfy specic
requirements of customers involved in international trade (Grosse and Goldberg, 1991)orbya
strategic decision to diversify abroad (Howcroft et al.,2011). Such an organizational structure is
associated with the opportunity for regulatory arbitrage because home authorities are generally
responsible for supervision of foreign branches of domestic banking groups (Fiechter et al., 2011).
Moreover, regulation affects the decision to offer cross-border banking services through a branch,
together with corporate taxation in the host country, degree of penetration of the host market and
level of economic and political risk in the host country (Cerutti et al.,2007). In light of the
heterogeneity of bank types internationally (Niepmann, 2015), empirical evidence demonstrates
that it is not only macro-economic factors that affect the choice to establish a foreign branch, but
also previous experience in the local nancial system and, more generally, the supply of
international banking services (Ball and Tschoegl, 1982) and the size and productivity of the bank
(Buch et al.,2011). Foreign banks operating in developed economies normally do not perform
better with respect to local nancial intermediaries (Chang et al.,1998); thus, exploitation of
economies of scale or scope remains weak. As a consequence, the main benetfrom foreign direct
investment by banks is normally ascribed to tax or regulatory differences among countries,
which could create an incentive to transfer assets, prots and losses to foreign afliates to
minimize taxes and regulatory costs (Berger et al.,2000).
Since the Global Financial Crisis (GFC), there has been some general tightening of
regulation of branchesof foreign banks. In particular, concurrently with localbanks, foreign
branches are subject to nancial and governance requirements, but application of capital
ratios is affected by equivalencebetween the regimes in the host and home countries(OECD,
2017). In Europe, convergence of the regulatory treatment of foreign branches stems from
the passport concept, giving European Economic Area (EEA) banks the right to provide
nancial services throughout the European Union (EU) based on a harmonized set of
prudential requirements, whereas the equivalence concept continues to apply to third-
country bank branchesat national-level markets (Margerit et al.,2017).
Given empirical studies on the effect of changes in regulation on bank branching in the US
market (Kroszner and Strahan, 2014) that demonstrate their importance for nancial integration
(Gilje et al.,2016), the empirical evidence for the European market is more limited,
notwithstanding the strong integration experienced over the last decade by the banking sect or
(Gual, 2004). Moreover, notwithstanding analysis of home-country regulation changes on the
activity of foreign branchesamong foreign afliates (Buch and Goldberg, 2017), little is known on
the impact of stand-alone application of regulatory instruments to branches in the host country to
avoid prudential leakage (Aiyar et al.,2014). Such analysis is particularly important in light of
the expectation of transformation of subsidiaries into branches (F
aykiss et al.,2013). Inside the
European market, the focus of analysis on the banking sector is motivated by exclusion of the
implementation of the EU equivalence regime for other nancial intermediaries, leading to
continued non-harmonization of the regulatory framework in accessing national European
markets by third-country banks (Deslandes et al.,2018). In light of the importance of capital
requirements for foreign investment in banks (Hasan et al., 2015) and based on the use of bank-
level data that overcomes limitations stemming from consolidated data, the present ana lysis
considers ownership of banks operating in the EU 28 area and focuses on non-EEA-owned banks
to test whether national-level applications of capital entry requirements and capital adequacy
requirements are signicant. Results show that the lower is the capital adequacy requirements,
the higher is the amount of loans anddeposits offered by banks with a non-EEA ultimate owner,
and the higher the probability of having a foreign bank operating in the country, in the form of
either a subsidiary or a branch.

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