competitors are used to work in countries with good institutions, a relatively high institutional quality in the host country will positively impact cross-border entry, while for banks that are more familiar with working in a country where institutions are weak, a relatively low institutional quality in a host country can be a reason to enter such a market. We find these institutional competitive advantage effects to matter even when controlling for similarity between host and source countries’ institutional quality.
Our results are important from a research perspective. They expand the previous literature on how institutional factors affect cross-border banking entry. They introduce the concept of institutional competitive advantage, which had previously only been used qualitatively, in an empirical rigorous way. They also shed light on how institutionally- sensitive sectors are affected by differences in countries’ rules, thus fitting in the growing literature on the institutional determinants of countries’ general development.
The results are also important from policy perspectives. For one, they show that high institutional quality is not necessarily a prerequisite to be able to attract FDI in banking. As the financial sector is an engine for growth and since foreign banks tend to have a generally beneficial impact on the domestic financial system, this is potentially good news for low-income developing countries that have poorly developed financial systems. However, some caution is warranted. The fact that banks with an institutional competitive advantage entering institutionally less developed countries are more likely to come from other institutionally less developed countries could create some risks. These foreign banks could become a source of instability in their host countries because they lack proper supervision in their source country, as has happened in some cases (BCCI is one notorious example). These foreign banks may take advantage of weak institutional environments in the host countries and exploit the safety nets provided to banks by taking on excessive risks. As such, increased foreign bank entry from institutionally less developed countries could pose risks that may require specific policy responses.
Our results also suggest a further research agenda. One area of future research is to investigate in more detail the source of institutional competitive advantage using additional and more specific measures of institutional differences. For example, whether institutional competitive advantage is based on differences in countries’ business environment or on differences in the way banks are being supervised, can be analyzed by