Foreign Banks’ Entry and Local Banks’ Strategies in China

• DOI: http://doi.org/10.1111/ajfs.12183
• Author: Xudong Chen,Liming Yao
• Published date: 01 August 2017
• Date: 01 August 2017

Foreign Banks’ Entry and Local Banks’

Strategies in China

Xudong Chen

College of Management Science, Chengdu University of Technology, China

Liming Yao*

Business School, Sichuan University, China

Received 17 April 2016; Accepted 5 March 2017

Abstract

The opening of the Chinese banking sector encourages the entry of foreign banks through

greenfield investment or cooperation with local banks. The entry strategies of foreign banks

are therefore influenced by the strategies of local banks. This paper examines the interaction

between local and foreign banks. The results demonstrate that the superior capabilities of for-

eign banks to liquidate collateral facilitate their greenfield investment. Otherwise, foreign

banks will cooperate with local banks, whose cooperation depends on local banks’ self-devel-

opment capability. Our results suggest that foreign banks are more likely to cooperate with

large local banks in China unless small local banks have greater self-development capabilities.

Keywords Foreign bank entry; Operating efficiency; Collateral liquidation capability; Tripar-

tite game; Equilibrium analysis

JEL Classification: C71, G21

1. Introduction

At the beginning of the 21st century, the reform of the Chinese banking system, essen-

tial for attracting foreign investment, has elicited extensive attention from both

domestic and international scholars. The Administrative Rules Governing the Equity

Investment in Chinese Financial Institutions by Overseas Financial Institutions,

This research is supported by the National Natural Science Foundation for Young Scholars of

China (Grant No. 71301109, 71501018), the Western and Frontier Region Project of Human-

ity and Social Sciences Research, Ministry of Education of China (Grant No. 13XJC630018),

the High-level Research Team Project of Sichuan Provincial Social Science, the Soft Science

Program of Sichuan Province (Grant No. 2017ZR0154), Funding of Sichuan University

(Grant No. skqx201726) and Funding of Research Center for Systems Science & Enterprise

Development (Xq17c06).

*Corresponding author: Liming Yao, Business School, Sichuan University, Chengdu 610064,

China. Tel: +86-28-8541-8191, Fax: +86-28-8541-5143, email: lmyao@scu.edu.cn.

Asia-Pacific Journal of Financial Studies (2017) 46, 635–660 doi:10.1111/ajfs.12183

©2017 Korean Securities Association 635

promulgated by the China Banking Regulatory Commission in 2003, stipulated that

the equity investment proportion of a single overseas financial institution in a Chinese

financial institution shall not exceed 20%, and that of all overseas financial institu-

tions shall not exceed 25%. Hence, these rules regulate how foreign banks, as strategic

investors, acquire minority ownership stakes in Chinese banks. Regulators effusively

praise foreign bank entry and stress that it helps improve Chinese banks’ operating

efficiency and promote their corporate governance. In response to this issue, some

local banks endeavor to enhance their operational efficiency by attracting foreign

investment (Berger et al., 2009; Ying, 2011; Allen et al., 2014), whereas others seek to

achieve success through self-development (Jeon et al., 2011; Wu et al., 2011; Hasan

and Xie, 2013). The Regulations of the People’s Republic of China on Administration

of Foreign Banks, issued at the end of 2006, further encouraged foreign investors to

establish foreign legally incorporated banks in China. By the end of 2013, there were

43 wholly foreign legally incorporated banks, 102 foreign bank branches,

1

and 26 for-

eign banks that had acquired minority ownership stakes in Chinese banks.

In the context of China’s banking reform, the entry of foreign banks into its

domestic market poses serious challenges regarding optimal entry mode, responses

of local banks, and incentives of policy makers, such as determining ways of guiding

foreign entry. More specifically, according to specific Chinese government policies,

foreign banks are entitled to choose their own entry modes. Is greenfield investment

or cooperation with local banks via minority holdings optimal for foreign banks? In

response to foreign bank entry, local banks have two strategies: cooperating with for -

eign banks or seeking self-development. Consequently, how do Chinese banks’ differ-

ent strategies influence the entry mode of foreign banks? Furthermore, how should

policy makers guide foreign bank entry from the perspective of domestic welfare?

Existing research on the entry modes of foreign banks has been conducted from

the perspective of mergers and acquisitions (M&A) as well as greenfield investment

(independent development). Tassel and Vishwasrao (2007) argue that to obtain local

customer information, foreign banks have an incentive to merge with local banks

since an informational disadvantage is imposed on foreign banks with an operating

efficiency advantage when they enter a host country. In terms of foreign banks’ entry

mode selection, Lehner (2009) claims that although foreign banks tend to merge with

local banks, thereby achieving information superiority in less developed countries,

they prefer greenfield entry in developed countries. Claeys and Hainz (2006, 2014)

show that foreign banks with screening technology advantages are able to gain infor-

mation advantages in terms of acquiring new clients. Nonetheless, they tend to merge

with local banks, thereby reducing information disadvantages for old customers.

These studies indicate that an information disadvantage is the principal factor for the

M&A mode of entry. However, due to minority equity policy constraints, foreign

banks acquire minority ownership stakes in Chinese banks.

1

Data are obtained from the annual report of the China Banking Regulatory Commission

(CBRC) and from other information that was available on the CBRC website in 2012.

X. Chen and L. Yao

636 ©2017 Korean Securities Association