institutional environment variables that relate to the hypothesis of institutional competitive advantage with respect to banking business.18 We use two indicators that overlap in time, are available for the vast majority of countries in our sample and that are related to banking business. One is the International Country Risk Guide (ICRG) composite indicator and the second is the Country’s Policy and Institutional Assessment (CPIA) index of the World Bank.19 We create the competitive advantage variables from these indexes the same way we create the KKM-based institutional competitive advantage variable.
The robustness regression results with these two institutional variables show similar results (rows 13-14) to those using the KKM variable. The only difference is that the semi-elasticities are smaller, about half those of the base regression. This could be because these indexes capture less well the institutional environment characteristics on which basis foreign banks make their entry decisions.
The literature on foreign banking has identified several factors that can influence the location decisions of multinational banks. In this paper we add to this literature by examining whether institutional competitive advantage, the ability of a foreign bank to deal better with the host country’s institutional environment than its competitors can, is a determining factor in a bank’s decision to enter a certain market. Our empirical results show that how the difference in institutions between the host country and source country compare to the difference for the bank’s competitors has a determining impact on the bank’s location decision. This implies that for those banks which compared to their
18 Currently available indexes that would be useful if they had been available for longer periods of time and/or for a larger group of countries include variables such as the coverage of credit bureaus, the degree of investor and creditor protection, the quality of information, collateral costs, and bankruptcy recovery rates and costs.
19 This index covers various aspects of a country’s policy and institutional environment and is prepared by World Bank staff on an annual basis, following a fixed template and methodology, with substantial internal review. The data go quite far back, even before our bank entry data, but do not cover developed countries and not all developing countries. We therefore set for all the developed countries the index to its highest level and only create an institutional competitive advantage variable for developing countries for which we have the CPIA data. As for some of the other indexes, the CPIA index is to some degree subjective, introducing possible biases.