The Economic Determinants and Engagement Models of Foreign Banks in Central Europe

In the last fifteen years foreign banks have expanded their presence significantly in almost all developing economies. The transition countries are among those economies that have experienced one of the highest levels of banking internationalization in the world. The foreign controlled banking asset in these countries ranges from 70 per cent in Poland to almost 100 per cent in Slovakia. With our study using panel data we examine the economic determinants of foreign bank engagement in the four local banking markets in Central Europe during the period 1994-2004. In addition, we study whether the economic determinants affect different entry vehicles of foreign banks into the Central European markets. Our results show that the most important factors determining foreign bank engagements were (i) large potential of the Central European banking markets and low degree of their financial sophistication (ii) the legal origin of the home country, (iii) the size of the economic growth rates differentials between host and home markets, and (iv) finally the distance between the host country and the foreign bank headquarter. We also find that most foreign banks investments occurred in the period of poor creditor rights protection. Moreover, our results present that the economic determinants had an impact on the decision of the organization form of the foreign banks entering the Central European banking markets. Our results are robust to several controls, including the lack of independence of investment decisions.