Banking and Capital Markets Analysis Across 8 Countries

Introduction and Analytical Framework

One of the steps in determining the best countries to target for overseas subsidiaries is examining different countries for the characteristics of their banking and capital markets. There are four main categories of characteristics that serve as the focal point of this report, applied to both 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 market's potential. Access reflects the market penetration for banking and finance, which can serve as a proxy for market potential. Depth is another factor that can highlight the size and potential of a given market.

Efficiency reflects whether there are synergistic opportunities. 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 also arise when the acquiring bank brings its operational expertise to the acquired institution (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 an opportunity to create shareholder value when, paradoxically, the acquisition target is underperforming (Krishnan, Hitt & Park, 2007).

Metrics and Methodology

There are eight metrics that are the subject of this study — one for each characteristic across 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 and there are also freestanding ATMs, this measure provides a more comprehensive picture of a country's consumer banking infrastructure. The depth measure is financial system deposits as a percentage of GDP. This figure reflects the degree to which people in a country use their banking system; a disparity between this and the access measure can highlight a country where wealth is so concentrated 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 noninterest fees as a complementary revenue source (DeYoung & Rice, 2003). A lack of efficiency in this area arguably creates an opportunity to adapt domestic noninterest revenue streams to a foreign context, helping to recapture some of the acquisition premium. The stability metric used is bank credit to bank deposits, a figure that highlights leverage within the industry and therefore its overall risk.

The capital markets measures are as follows. The access measure is market capitalization excluding the top ten companies. In many countries, a handful of dominant companies can skew the apparent size of local markets; once the top ten are excluded, the remaining market size can indicate the breadth of access that firms have to the capital market. The depth measure is the stock market's total value traded as a percentage of GDP. While this measure does include the top ten companies, its value lies in showing how much the local stock market reflects the size of the local economy. Although in some cases this could be skewed by companies listing overseas (for example, Israeli companies listing in the United States, making the Israeli market appear smaller than it is), for most countries this measure should deliver an accurate reflection of market depth. The stock market turnover ratio serves as the efficiency measure, since higher turnover indicates higher liquidity and a more efficient market. Stock price volatility is the stability measure used; it is best examined in context with major stock markets, since even large exchanges experience some volatility. This measure also correlates somewhat with depth, as markets with less depth tend to have less stability.

Country Overviews and GDP Context

The countries chosen for this examination are a varied mix, selected based on management specifications. They are Germany, Hong Kong, Mexico, Sri Lanka, Nigeria, Egypt, Malaysia, and Russia. For ease of comparison, figures for the UK are also included. The report compares each of the eight metrics in turn, highlighting the strongest and weakest outliers within the group, before rendering a conclusion identifying the top three countries for further investigation as potential acquisition partners.

A brief overview of the economies is useful context. Several of these countries are petro-economies — Malaysia, Russia, and Nigeria in particular. Egypt has been in a volatile political and economic state, as has Sri Lanka until relatively recently. Most of these countries lack a fully functioning modern democracy, and several have characteristics of fragile states. This report does not give extensive discussion to political risk, as it is assumed that future reports on target countries will investigate that subject in greater detail. The focus here is strictly on the metrics that inform opportunities in banking and capital markets. The GDP growth data below is sourced from the CIA World Factbook (2014).

As the GDP growth figures indicate, most economies in this group are growing more rapidly than the UK. Germany is an exception — while a strong economy, it is being held back by Eurozone weakness. Sri Lanka is the smallest economy studied but also the fastest-growing, which is unsurprising given the recent end of its civil war; construction in particular has been a significant driver during this period of peace (ADB, 2014). Malaysia is also showing robust growth. Even with strong oil prices in those years, Russia failed to generate exceptional economic growth. Nigeria, for its part, is becoming a significant economic story, rivalling Egypt and South Africa for the status of Africa's largest economy.

References

ADB (2014). Sri Lanka: Economy. Asian Development Bank. Retrieved December 8, 2014 from http://www.adb.org/countries/sri-lanka/economy

CIA World Factbook. (2014). Website, various pages. Central Intelligence Agency. Retrieved December 8, 2014 from https://www.cia.gov/library/publications/the-world-factbook

DeYoung, R. & Rice, T. (2003). Noninterest income and financial performance at U.S. commercial banks. Federal Reserve Bank of Chicago. Retrieved December 8, 2014 from https://www.chicagofed.org/digital_assets/publications/risk_management_papers/sr_2003_2.pdf

Ganegodage, K. & Rambaldi, A. (2013). Economic consequences of war: Evidence from Sri Lanka. University of Queensland. Retrieved December 8, 2014 from

Haunschild, P. (1994). How much is that company worth? Interorganizational relationships, uncertainty and acquisition premiums. Administrative Science Quarterly, 39(3), 391–411.

Krishnan, H., Hitt, M., & Park, D. (2007). Acquisition premiums, subsequent workforce reductions and post-acquisition performance. Journal of Management Studies, 44(5), 709–732.

Sirower, M. (1997). The Synergy Trap: How Companies Lose the Acquisition Game. Free Press: New York.