Application of Dunning's sclactic theory in banking

The application of the eclectic theory has managed to capture a diverse set of hypotheses under its umbrella. As such, a large number of factors affecting bank internationalization have been identified under the three forms of advantage: ownership, location and internalization. Table 3.2 presents a comprehensive list of these factors grouped under the three advantages. This section will not discuss all these factors, but rather will demonstrate the nature of each type of advantage in banking. The discussion will deal first with each advantage separately, and will then evaluate the whole framework.

The major ownership advantages identified are the MNB's motivation to exploit reputation, its expertise, its proprietary customer information and economies of scope and scale. A foreign venture which can access information and commercial intelligence residing in the MNE's network can make more accurate assessments of the risks involved in lending and the needs of the target market. For example, a U.S. bank's foreign operation, dealing with U.S enterprises overseas, can make lending decisions based on information

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T a b l e 3 . 2 . O w n e r s h i p , l o c a t i o n an d i n t e r n a l i z a t i o n a d v a n t a g e s

Aliber 1984; Tschoegl 1987;

Campayne 1990.

Yiannopulos 1983; Tschoegl 1987.

Yiannopulos 1983; Cho 1985.

Tschoegl 1987; Casson 1989;

Enderwick 1989; Campayne 1990.

Yiannopulos 1983;

Gray and Gray 1981; Enderwick 1989.

Yiannopulos 1983; Campayne 1990;

Cho 1985.

Gray and Gray 1981; Nigh et al. 1986.

Ball and Tschoegl 1982; Cho 1986.

Yiannopulos 1983; Cho 1986.

Gray and Gray 1981; Cho 1985;

Yiannopulos 1983; Grubel 1989.

Sabi 1988; Fisher and Molyneux 1996.

Campayne 1990; Brealey and Kaplanis 1996.

Internalization Advantages

Yiannopulos 1983; Tschoegl 1987.

Enderwick 1989; Campayne 1990.

Grubel 1977; Campayne 1990;

Casson 1989.

Gray and Gray 1981; Yiannopulos 1983.

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residing at head-office due to its close conduct with the parent client. Furthermore, this bank can differentiate its services to U.S nationals overseas. Grubel (1989) has argued that American Express offices overseas, knowing the needs of the American tourists, provide an environment that makes such tourists feel at home. According to this author, retrieving such information costs very little since the information resides in the MNB, and most importantly, there is no market where competitors can buy it.

Table 3.2 indicates that the important ownership advantages in banking are intangible due to their information-intensive nature. Such information is specific to the bank and therefore, if it is used properly can result in competitive advantages. However, transaction cost theory suggests that MNBs are susceptible to transaction costs due to the intangible nature of their important resources, and that therefore protection of these resources is necessary. This linkage of ownership advantages with transaction costs suggests that such factors can be employed to explain the entry mode selection. For example, MNBs motivated to exploit differential access to information when servicing a foreign market should select high control entry modes.

A number of studies, applying Dunning's theory in banking, have treated ownership advantages as given (Gray and Gray 1981; Cho 1986), and assumed that the MNB has the resources to compete in foreign markets. For example, Gray and Gray (1981) have stated that ownership advantages

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"derive from size and the established position of the corporation".

This assumption is an oversimplification of the problem because MNBs compete with other MNBs in international markets. In this case, size and position are not adequate ownership advantages because all competitors posses them.

Another reason for not studying ownership advantages, is the difficulty of operationalizing them due to their intangible nature. For example, Cho (1986) has used the parent bank's size to represent ownership advantages. He has claimed that this variable is positively related to the resources which a bank can commit to its foreign operations. This measurement is not adequate, however, because size alone cannot reflect a bank's marketing skills for example.

Banks can achieve internalization advantages from a number of sources. Gray and Gray (1981) have suggested a comprehensive list of such sources which are shown in Table 3.2. These authors have viewed the MNB as a network of operations and have conceived the benefits arising by exploiting synergies among the different international operations of the MNB. They have argued for example, that the MNB's ability to control internal fund flows can reduce external transaction costs, can facilitate global asset and liability management, so that they can shift funds globally to their most profitable use.

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Yiannopulos (1983), taking a similar approach, has argued that information production is characterised by economies of scale and learning, and that therefore an extensive network of operations can enhance the quality and reliability of the information residing at the MNB.

In general, the internalization advantages identified in Table 3.2 accrue when an additional market is internalised. The benefits are significant when the links between operations are managed efficiently. This argument implicitly acknowledges the importance of coordination and control in reaping internalization advantages. According to business strategists (Porter 1986; Hill et al. 1990), under such conditions the MNB should prefer high control entry modes. This discussion demonstrates that the eclectic theory can address issues related to the international strategic behaviour of the individual bank and particularly, that it can explain the entry mode selection.

Studies applying Dunning's theory to banking have considered internalization as an offensive strategy. They have regarded the MNB as a means of reaping internal synergies. However, there is a defensive dimension in internalization as well. MNBs can internalize a new venture in order to protect their ownership advantages which can easily be disseminated or undervalued in open markets

(Rugman 1981).

The defensive explanation has not been considered adequately by bank studies despite the information­

intensive nature of the industry. This can be attributed to

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the approach of the eclectic theory, which focuses on the exploitation of advantages rather than the prevention of risks. Empirical research on this topic has followed a similar approach. Cho (1986) for example, has approximated internalization advantages through the economies achieved from sharing resources internally. This factor has been measured as the amount of assets and liabilities transacted within the M N B 1s network. Cho has not found internalization advantage to be a significant explanation of bank foreign investment, which he has attributed to the operationalization of the variable. In general, the measurement of internalization advantages is a difficult task because they are not easy to identify (Dunning 1993).

Once the ownership and internalization advantages are identified, the configuration of the operations can be considered. This is because synergies and ownership advantages can be constrained or facilitated from location factors. As Table 3.2 shows, sources of location advantage can result from different national regulatory frameworks, lower operating costs and the presence of existing clients.

Favourable regulation has been supported as an important motive for bank foreign presence (Dahl 1975, Fieleke 1977, Goldberg and Saunders 1980). Regulation differentials could take the form of exchange controls, tax brakes and reserve requirements. The growth in Euromarkets, for example, has been explained by the ability of the multinationals to offer competitive pricing due to

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favourable regulation on reserved funds (Yiannopulos 1983) . In general, MNBs should prefer investing resources in the most attractive locations. This can be achieved by shifting funds to their most profitable use through the MNB's international network (Yiannopulos 1983).

The above argument demonstrates the importance of considering the configuration of all three advantages (ownership, location and internalisation) to explain the internationalization decisions of a bank. However, empirical research has paid disproportionate attention to location advantage (Nigh et al. 1986; Jain 1986; Sabi 1988;

Campayne 1990; Brealey and Kaplanis 1996) . This can be attributed to the availability of aggregate data of country level (e.g. business presence away from home, regulation, interest rates and production). For, example Nigh et al.

(1986), studying the U.S. banking activity overseas at industry level, have examined factors such as the presence of other U.S. firms, regulation and local opportunities.

They have not studied any location factors which are specific to an individual bank, e.g. interest rate differentials, market competitiveness and network configuration, because they have argued of the difficulty in finding comparable data.

Most empirical studies have followed a similar approach, and thus have to be considered inconclusive. This is because location advantages are not studied at firm- level and therefore the management's evaluation of these advantages is not considered. These studies have indirectly

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assumed that all banks react the same way to advantages identified at different locations. This, however, cannot be true, given the variety of location strategies pursued by different MNBs. Discussion in section 3.2.1 has indicated that new international banking opportunities should give more choices to banks to develop their bank-specific location strategies.

After the discussion of each advantage, the whole framework will be evaluated.

Unlike most of the hypotheses which employ analysis at macro or meso-level, the application of Dunning's framework to banking emphasizes the firm as well. This is because besides patterns of FDI, it attempts to explain the actions of the individual bank. This can be demonstrated by the emphasis placed on the internalization of the bank's ownership advantages. The analysis of internalization goes a step further to recognise, for example, the link between the benefits of having differential access to customer information and the ability to efficiently share such intelligence within the international network of the bank.

This approach, which focuses on the motivations of the individual bank, can provide explanations for the internationalization decisions of a particular bank. For example, Citibank's internationalization strategies have been studied within this framework (Cleveland and Huertas 1985) .

Most importantly however, the application of the

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eclectic paradigm sees the firm as a network of international operations and recognises the importance of coordinating and configurating that network in the most efficient way. This approach has the capability to address global motivations of the MNB. It therefore supports Dunning's (1993) argument that the framework is capable of capturing the competencies and international strategic motives of the MNE as developed by the field of business strategy.

The application of the framework however, is susceptible to the weaknesses of Dunning's paradigm discussed in Chapter 2. The three main deficiencies from the perspective of this study are primarily the failure to recognise the existence of international competition and its effects on the bank's evaluation of its ownership advantages. This in turn affects the bank's motivation in internalizing or choosing foreign markets.

In addition, while the framework quite successfully identifies and discusses the ownership advantages which act as a motive for internationalization, it does not recognize other motives such as the bank's attempts to protect its ownership advantages or access new ownership advantages.

Furthermore, while the framework highlights the motives for multinationality, it neglects the risks which are associated with foreign investment (for a comprehensive list of these risks see Root 1987, p. 129) and which directly affect the level of commitment in a foreign market

(Aharoni 1966; Davidson 1982).

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Finally, empirical studies focus almost exclusively on the examination of location-specific factors (Night et al.

1986; Sabi 1988; Campayne 1990). This is due to the difficulty of measuring ownership and internalization factors through proxy variables. However, studying one or two advantages only may not be adequate because, as Dunning (1993) argues "it is the configuration of all three advantages that determine the growth of the multinational".

In summary, the application of Dunning's eclectic theory in banking identifies a comprehensive list of factors inhibiting internationalization. These factors are often viewed as MNB motives for internationalization and are applied at firm level. This application of Dunning's theory also stresses the issue of control in a foreign operation as it recognises the intangibility of a bank's assets and the importance of coordinating its network of operations. The application, however takes an offensive approach, thereby neglecting the risks involved in foreign markets.

In the next section the application of the process model in banking will be discussed. Given its emphasis on risks, it should be considered as a complement to Dunning's eclectic theory.