The purchase of developing country banks by global banks can be mutually beneficial. But accompanying corporate governance issues such as a lack of transparency must be addressed. Guillermo Ortiz explains.

In recent years, global banks have acquired many large retail banks in Latin America and other emerging markets. The acquisition of stable local depositors’ bases in these countries has allowed global banks access to the profitable local household sectors through credit cards, mortgage loans and insurance products. The acquisition of local banks by more efficient financial entities brings many benefits to everyone involved by facilitating the access of acquired banks to new products and technologies and allowing parent banks to achieve higher economies of scale and to diversify their risks.

Despite the benefits, the purchase of local banks by foreign financial institutions poses challenges for host-country authorities and markets. To begin with, it often results in the loss of minority shareholders, which simplifies the management of the acquired bank at the expense of corporate governance and the listing in local stock exchanges. Thus, host countries lose the information derived from stock price behaviour and independent analysts’ research, as well as the advantage of having widely held banks – all of which is universally considered to be desirable.

Global banks also tend to centralise important strategic and risk management decisions at their head offices. They tend to adopt ‘matrix’ reporting arrangements whereby local treasurers, comptrollers and risk managers report directly to the parent bank’s counterparts rather than to their local CEO. This may be at the expense of the acquired bank.

For example, the growing trend of registering derivatives operations at special off-shore hubs, and the booking of transactions where funding and regulatory costs are lower are practices that move revenues away from the local bank where the business originated.

This asymmetry between rewards and responsibilities is a challenge for host-country authorities when large local retail banks are involved, because of the crucial role that they play in providing economic agents with access to payment systems, in the functionality of a local safety net and in the efficient allocation of resources. This is particularly true in emerging economies, where access to capital markets is limited.

Global banks also establish individual limits to credit exposure in each foreign country, according to the sensitivity of the global bank’s overall portfolio. Thus, host-country banks must reduce their exposures when they exceed the limits set by the parent bank, although local exposures are financed in host-country markets and currencies.

Since the expansion of global banks into the retail business is taking place mainly through the acquisition of existing entities abroad, it leaves host countries’ market structures largely unchanged. While improvements are tangible in the derivatives and money markets, efficiency gains in other sectors result in higher profits rather than consumer benefits. Following the trend of more developed markets where lending to businesses is losing importance, acquired banks are aligning domestic policies with their parent banks’ priorities, and diverting credit away from local companies into the more profitable consumer sector. In addition, risk-adjusted interest charges and fees tend to be considerably higher in local markets than those observed in the parent bank’s home market. This is harmful in less developed countries, where small and medium-sized enterprises (SMEs) have limited access to capital markets, and consumers generally have a lower purchasing power.

The way ahead

The relevant question is not whether globalisation is good or bad, but how to benefit from it. Primarily, the right incentives to steer decisions in the acquired banks’ best interests must be set. One possibility is to have minority shareholders sit on boards of large foreign-owned banks, thus enhancing corporate governance and facilitating the listing of large retail banks in local stock exchanges. Next, measures must be taken to give SMEs access to bank credit through credit bureaus and rating agencies.

Transparency and disclosure must be encouraged to increase competition in local markets. In the household sector in particular, banks must be required to disclose interest rates, commissions and fees. Finally, action should be taken to ensure that credit and debit cards’ interchange fees are set competitively.

Guillermo Ortiz is governor of the Central Bank of Mexico. These are the author’s views and do not necessarily reflect those of the bank’s board.

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