Evaluating International Banking and Capital Markets for Acquisition Targets

Introduction and Framework

One of the steps in determining the best countries to target for overseas subsidiaries is by examining different countries for the characteristics of their banking and capital markets. There are four main categories of characteristics that will be the focal point of this report, for each of the banking and capital markets. The four main characteristics are access, depth, efficiency, and stability. For a company seeking a country in which to enter, each of these has particular relevance for both the size of the market and the potential of the market.

Access reflects the market penetration for banking and finance, which can be seen as a proxy of sorts for market potential. Depth is another factor that can highlight the size and potential of a given market. The efficiency reflects whether there are synergistic opportunities. Remember that companies making acquisitions will always pay an acquisition premium above and beyond the current market value of the acquired firm (Haunschild, 1994). While in some cases there will be synergistic benefits accruing from geographic diversification, especially when part of a broader globalization strategy, operational synergies can come when the acquiring bank brings its operational expertise to the acquired bank (Sirower, 1997). The acquiring bank would be able to improve the acquired bank, thereby increasing its value. The acquired bank is unlikely to be able to fully price this in, so there is opportunity to create shareholder value, ironically, when the acquisition target is underperforming (Krishnan, Hitt & Park, 2007).

The Metrics

There are eight metrics that are the subject of this study, one for each characteristic for banking and capital markets. For the banking industry, the access metric is the availability of ATMs per capita. This data is widely available and serves as an effective proxy for banking density at the consumer level. Bank branches are sometimes cited, but since most branches have ATMs, yet there are freestanding ATMs as well, this measure is a more comprehensive study of a country's consumer banking infrastructure. The depth measure is the financial system deposits to GDP. This percentage reflects the degree to which people in the country use their banking system, and a disparity between this and the access measure can highlight a country where wealth is concentrated such that a sizeable infrastructure does not necessarily mean that people can or are willing to use it.

The efficiency metric is bank noninterest income to total income, which illustrates the sophistication of the banking system. The world's most sophisticated banking systems have relied on ever-increasing use of non-interest fees in their revenue as a complementary revenue source (DeYoung & Rice, 2003). Arguably, a lack of efficiency here creates an opportunity to adapt domestic non-interest revenue streams to the foreign context, to recapture some of the acquisition premium. The stability metric commonly used is bank credit to bank deposits, a figure that highlights the leverage within the industry and therefore its overall risk.

The capital markets measures used are as follows. The access measure is the market capitalization excluding the top 10 companies. In many countries, there may be a handful of dominant companies that skew the size of the local markets. But once the top ten companies are excluded, the size of the remaining market can be an indicator of the breadth of access that firms have for the capital market. The depth measure used here is the stock market's value of total traded to GDP. While this measure does include the top 10 companies, its value lies in how much the local stock market reflects the size of the local economy. While in some cases this could be skewed by companies listing overseas (for example, Israeli companies listing in the US, making the Israeli market look smaller than it actually is), for most countries this measure should deliver an accurate reflection of the market depth. The stock market turnover ratio is the efficiency measure used, as higher turnover indicates higher liquidity, meaning the market is more efficient. Stock price volatility is the stability measure that will be used. This is probably best examined in context with major stock markets, as even they can have some volatility. This will also correlate somewhat with depth, as markets with less depth probably have less stability.