Effects of Foreign Capital Entry on the Macedonian Banking Industry: Two-Edged Sword

Introduction

Since the fall of Berlin Wall and fall of the socialism, financial globalisation has brought new radical changes to the financial landscape of emerging and transitional markets. The financial markets worldwide are transformed. Deregulation, privatisation and foreign bank entry are main economic movements in a number of emerging banking systems during the last decades as a response to social and economic forces/changes. Foreign banks have increased their presence and share, primarily due to liberalisation of financial marketsin these countries. However, there is still significant debate (pro et contra) over cost and benefits caused by financial liberalisation, and especially with increase of foreign bank participation vis a vis domestic banks. On the one hand, governments fear that foreign banks will engage in cherry picking¹(cream de la cream), leaving the domestic banks with bad loans in their portfolio. Moreover, the local banking market can benefit from the better technologies that foreign banks use through learning and spillover effects (Claeys and Hainz, 2006). Importantly, Lensink and Hermes (2004a) argue that at lower levels of economic development, banking markets are generally also less developed, which means that in these cases spillovers of banking techniques and practices may be more important; implementing them, however, raises costs, at least in the short term. Additionally, Hermes and Lensink (2004b) find that foreign bank presence is associated with higher costs and margins of domestic banks at low levels of financial development while it is associated with falling costs and margins of domestic banks at higher levels of financial development. In brief, the effect of foreign bank shows different results according to the different levels of economic development and random exogenous factors (Li and Kim, 2011).

Financial liberalisation around the world is often viewed as two-edged sword. Foreign banker once had a nasty ring to it, like carpetbagger or loan shark. In the harshest terms, foreign banks were seen as parasites that were out to drain financial capital from their hosts (Morgan and Strahan, 2003). But times and traditions (mores) have changed. Advocates of financial globalisation believe that foreign banks can meet a wide capital demand and introduce advanced technology², new financial products and financial innovations. They emphasise the enhancement of financial competition and improvement of financial performance. However, opponents of financial globalisation consider foreign banks to cause the instability of bank sectors and increase loan losses of domestic banks. In particular, the credit strategy of foreign banks has a likely adverse effect, leading to financial service market segmentation and domestic banks are forced to take risks, which may decrease operational efficiency. Although some consensus is reached, whether foreign banks induce the increase or decrease in financial performance is still under discussion, the most difficult issue on which to reach a consensus (Li and Kim, 2011).

On top of this, Havrylchyk and Jurzyk (2010) find a positive impact of foreign bank ownership on acquired banks' performance, as well as on their market power, in sense that banks become more profitable due to cost minimisation and better risk management, as well as gain market share. Generally, foreign credit to emerging markets is viewed as one means for deepening emerging capital markets and potentially reducing the severity of crises when they occur (Goldberg, 2001). Conversely, Adams-Kane, Caballero and Lim (2013) suggest that domestic monetary authorities should be aware of the potential for greater credit contraction by foreign banks, and support domestic liquidity formation during crises accordingly.