methodology to measure and employ institutional competitive advantage may have broader applicability. Second, our findings relate to the more general research on the role of institutions in development. While institutional quality has been found to affect country growth patterns and other aspects of development, much remains unexplained, including how economic actors “overcome” institutional weaknesses and how internationalization may help or hinder institutional development. Since banking is an institutionally-intensive activity, the location decision of foreign banks provides insights on how institutional differences may be dealt with more generally. Lastly, the finding that relative differences in institutional quality can drive cross-border entry in banking suggests that there is scope for increased cross-border entry among certain groups of countries, such as among developing countries, with potential associated benefits in the form of better and more efficient financial services provision. When source countries are developing countries, however, which are not of the highest institutional quality themselves, these benefits will have to be weighed against risks arising from, among others, poor home country supervision and poor incentive structures.
The rest of the paper is structured as follows. In Section 2 we describe the database used for foreign bank entry and show some basic patterns. Section 3 describes the methodology used. Section 4 includes the main results and various robustness tests. The last Section concludes.
Bank Entry Data We construct a database that contains information on host country and source country bank ownership.1 We do this for an extended period (1995-2006), covering all foreign bank entry and exit over this period, which allows us to explore the variation over time and to avoid some of the econometric issues related with cross-sectional regressions. Our primary source of information is Bankscope, an international dataset of balance-sheet items and ownership information of individual banks. The coverage is comprehensive,
For a full description of the database see Claessens, Van Horen, Gurcanlar and Mercado (2007).