Posted: March 18th, 2023
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 the access, the depth, the efficiency and the 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 (Krishan, Hitt & Park, 2007).
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 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 going to be 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 in 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 source of complementary revenue (DeYoung & Rice, 2003). Arguable, a lack of efficiency here creates an opportunity to adapt domestic UK non-interest revenue streams to the foreign context, to recapture some of the acquisition premium. The stability metric commonly used 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 ex-top10 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 will be the stock market’s value of total traded to GDP. While this measure does include the top 10 companies, the value of this measure is just 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 (i.e. Israeli companies listing in the U.S., 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 will be the efficiency measure used, as higher turnover indicates higher liquidity, which is to say 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 a little bit with depth, as markets with less depth probably have less stability.
The countries chosen for this examination are a motley mix, but were based on specifications that management wanted such a mix. The countries are as follows: Germany, Hong Kong, Mexico, Sri Lanka, Nigeria, Egypt, Malaysia, and Russia. For ease of comparison, figures for the UK will also be included in the report. The structure of the report will be to make comparisons of the different metrics, to highlight the strongest and weakest outliers among this chosen group of countries. This will be done for each of the eight metrics that are studied. The report will then render a conclusion that identifies what the authors believe to be the top three countries for further investigation for a potential acquisition partner.
The first step of this process is to provide a general sense of the state of the economies in these different countries. Several of these countries are known to be petro-economies (Malaysia, Russia, Nigeria in particular). Egypt is in a volatile state, and Sri Lanka was not too many years ago. Most of these countries lack any semblance of modern democracy, and several are borderline failed states. This report will not give undue discussion to matters of political risk, as it is assumed that future reports on target countries will investigate that and other subjects in greater detail. The focus of this report will be strictly on the metrics that inform the opportunities in the banking and capital markets of these nations. First, a brief table presenting the current and recent GDP, along with growth rates (all sourced from the CIA World Factbook, 2014).
As the chart indicates, most economies are growing more rapidly than the UK economy. The Germany economy is an exception — while a strong economy it is doubtless being dragged down by Eurozone weakness. Sri Lanka is the smallest economy being studied, but it is also the fastest-growing. This is not surprising, given the recent end of its civil war. Construction in particular has been a significant driver in this time of peace (ABD, 2014). Malaysia is also showing robust growth but even strong oil prices in these years was not enough to spur unusual economic growth in Russia. Nigeria, for its part, is becoming a robust economic story, rivalling Egypt and South Africa for status as Africa’s largest economy.
Data Analysis — Banking Industry
First, the banking industry will be discussed. Russia has the highest access in its banking industry, with strong showings coming from Hong Kong. Weak access is reported from Nigeria and Egypt. Germany banking access is at surprisingly low levels, far below what would be expected from a modern economy.
With respect to market depth, Hong Kong has incredible market depth, while the UK did not register on our chosen metric. Germany and Malaysia also held reasonable levels of market depth, while Mexico and Nigeria had low levels of depth. Despite its broad access, Russia also showed a fairly low level of market depth.
Russia and Hong Kong enjoy the highest scores for banking industry efficiency, well above UK levels. The Germans are on our level. The developing world nations all have relatively inefficient banking systems, in particular Sri Lanka. Of the countries studied, Russia has the greatest market stability. Say what you want about political risk, but Russia’s oil wealth has allowed its banking sector to enjoy a higher level of stability than the other nations. German banks were less stable, having been weakened somewhat by the recession and the Eurozone crisis. Egypt has the least stable banking system, and this was always the case even before that country’s recent political troubles. Sri Lanka’s banking system has a relatively high level of stability, as does that of Malaysia, both countries roughly at Germany’s level.
Overall, the country that stands out as having the best metrics for the banking industry is Hong Kong. While the bank stability is not great — perhaps a reflection of PRC control over the territory and consequent departure of major banks like HSBC to safer places, the other metrics are strongly in Hong Kong’s favour. There is still a significant opportunity as Hong Kong is seen as the West’s window into China, a proxy investment in Chinese growth, but with a more or less British legal system and Western capitalist characteristics.
Sri Lanka is the only other really promising country in this group. While Mexico and Malaysia are decent performers on the metrics, there is no excellence in any one area that would signify a great opportunity. The optimal time to invest in those countries may have passed. Sri Lanka, on the other hand, is benefiting from an upsurge in growth relating to the country’s emergence from civil war. The country was a growing economy before the war, a pattern that has picked back up almost immediately after the government victory (Ganegodage & Rambaldi, 2013). Combining the stability of the banks with their operational underperformance and a solid economic growth rate means that Sri Lanka represents a good opportunity to perhaps invest in a country before it becomes overpriced.
Data Analysis — Capital Markets
Of the country’s studied, several markets have equally high access — Malaysia, Hong Kong and Germany are all comparable to the UK in terms of capital market access. With respect to depth, however, Hong Kong is not comparable to anywhere else. Hong Kong has exceptional market depth, five times the level of the UK. The other countries tend to have relatively poor depth scores, even Germany. Nigeria in particular barely has a stock market — any Nigerian company worth incorporating probably lists in London.
Not surprisingly, Hong Kong has the greatest level of market efficiency. However, Germany and Russia also have efficient financial markets. Nigeria’s financial markets are horribly inefficient — again this is a country that despite its economic promise has almost no stock market to speak of. The other developing market countries on the list do not have particularly efficient stock markets either, though they are at least functional.
Egypt has high market stability, even if this is its only attribute. Germany and Hong Kong also perform well on market stability measures, not surprisingly. Malaysia’s stock market is notably volatile, relative to all others on the list, though it should be noted that volatility figures were not available for Russia.
The capital markets analysis is perhaps less clear than the banking industry analysis. There is no clear nation that outperformed all others. That said, Germany and Hong Kong were the most steady performers, which should surprise nobody. Frankfurt and Hong Kong are two of the biggest stock markets in the world. Among emerging markets, none stood out as particularly attractive, though Nigeria was particularly unattractive. Egypt was probably the best performer among them, but the measures were simply not strong enough to offer a powerful recommendation to recommend that country. A bad day of business in Hong Kong or Germany would be worth more than the Egyptian market, especially when political risks and liquidity are taken into consideration.
The two markets that stand out the most are the ones that stand out for their banking sectors. Hong Kong is a nation in which we probably already have a presence, but expanding our business there is recommended. Not only is Hong Kong a proxy for the PRC in many ways, but the metrics for its banking and financial systems are exceptional. It is, simply put, a good market in which to operate. The cost of getting into the Hong Kong is a different issue — it is far from an undiscovered gem. But on pure metrics not taking cost or qualitative factors into account, Hong Kong is a highly desirable market.
If the bank wants a good bargain-hunting option, Sri Lanka is a good story. The nation has emerged from its civil war with steady, strong economic growth. The banking system is stable, but suffers from underinvestment. But there is some market access, and depth, indicating that Sri Lanka is not a failed market by any means. That its financial institutions were able to weather the civil war and emerge intact and stable indicates that this is a market with strong fundamentals.
The metrics are on Sri Lanka’s side as well. There are concerns that the stock market metrics are not as strong as one might like, but they are in line with those of the other developing economies on this list. Further, Sri Lanka might well be underpriced, as much more attention is typically paid to larger emerging markets, especially neighbouring India. But for value, Sri Lanka holds a lot of promise.
Lastly, despite its economic promise, Nigeria is a debacle. The country has by far the least developed financial and banking infrastructure among its developing world peers, and this lack of structure and stability is an impediment to the sort of growth that would allow the bank to recapture the acquisition premium it will have to pay to enter that market.
Appendix A: Data Tables & Graphs
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
Ganegadoge, K. & Rambaldi, A. (2013). Economic consequences of war: Evidence from Sri Lanka. University of Queensland. Retrieved December 8, 2014 from http://www.uq.edu.au/economics/abstract/453.pdf
Haunschild, P. (1994). How much in that company worth? Interorganizational relationships, uncertainty and acquisition premiums. Administrative Science Quarterly. Vol. 39 (3) 391-411.
Krishnan, H., Hitt, M., & Park, D. (2007). Acquisition premiums, subsequent workforce reductions and post-acquisition performance. Journal of Management Studies. Vol. 44 (5) 709-732.
Sinower, M. (1997). The Synergy Trap: How Companies Lose the Acquisition Game. Free Press: New York.
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