Foreign branches and subsidiaries
Foreign branches are banks, just like local banks, and can offer the same types of services.They are subject to the same rules and regulations as local banks but many countries also impose other restrictions on deposit taking and local expansion.
Foreign branching has grown dramatically with the growth of international banking in general.The European Union has also seen a proliferation of cross-border branches of other Union members as well as the growth of Union member branches in the United States and Asia.Japan’s banks have followed its commercial successes and established branches in most of the major financial centers.Most countries have at least one or two banks with a network of branches in the major financial centers.
Foreign branching has grown for many reasons.Firstly, commerce has become intrinsically international in nature.It is rare for a medium-sized company to be isolated from foreign suppliers and customers and many of the larger companies do more business abroad than they do in their home markets.Establishing a foreign branch was a way of keeping clients that might otherwise have been lost.Secondly, a foreign branch affords access to foreign money markets.This access is indispensable to the larger banks that have funding needs in many currencies.It also offers them investment opportunities that might be unavailable in the domestic market.Finally, foreign branching is a way to diversify cash flows.Economic expansion and contraction varies across countries.A downturn in Japan might accompany an expansion in the EU or the United States.Since banking activity is closely tied to economic activity, a diversified geographical presence should give a diversified range of cash flows.
While foreign branching has been widespread, its growth has been curtailed because most countries restrict branch banks’ activities in order to protect local banks from aggressive competition.This was true in many EU countries where local banks grew bloated and inefficient.The United Kingdom has been comparatively liberal in allowing foreign banks to operate and it owes its position as a major financial center partly to that.Banking restrictions for EU member banks came down in 1992 and this caused a flurry of merger activity as local banks positioned themselves for a competitive onslaught.The International Banking Act of 1978 provides for the regulation and supervision of foreign banks in the United States.They may be granted a license in states where this is allowed but are restricted to that one state.They have access to Federal Reserve services and must respect reserve requirements and provide deposit insurance.
Rather than establish branches, some banks decide to create a subsidiary.A subsidiary differs from a branch insofar as the branch is part of a company that is incorporated elsewhere whereas the subsidiary is incorporated locally and owned either completely or partially by a foreign parent.Generally speaking, a subsidiary is indistinguishable from a locally owned bank.Most major countries provide some scope for foreign subsidiary banking.
Branches and subsidiaries have the advantage of expanding a bank’s presence and offering a wider range of international services to its home clients as well as the possibility of cultivating local clients.On the other hand, branches and subsidiaries are costly to start up and run.They need to generate a considerable amount of business to make them worthwhile and it may take years before they establish a presence.For this reason many banks try to enter a local market through a merger or acquisition.
Mergers and acquisitions make it possible to “hit the ground running”.An existing bank is agoing concern.It has an ongoing deposit base, a functioning management team knowledgeable in the customs and culture of the home country, and a network of contacts and clients.For these same reasons, mergers and acquisitions are expensive.Furthermore, they don’t always work.In fact, they often fail and failures are costly both financially and in terms of reputation.