The complex relationship between bank entry and the technological gap

industry’s or a country’s own technology or productivity in capturing knowledge spillovers, the general literature provides two alternative views. First, some argue that increased technological backwardness should enhance knowledge spillovers as the potential for knowledge spillovers is sufficiently large in that case (Findlay, 1978; Wang and Blomstrom, 1992). Secondly, others claim that firms need a minimum amount of absorptive capacity to be able to capture knowledge spillovers (Cohen and Levinthal, 1990; Glass and Saggi, 1998). Such absorptive capacity is created from investments in research and development (R&D) or human capital and provides

elementary knowledge or technology that are necessary to assimilate and exploit external knowledge. Providing that the extent of spillovers depends on difference in economic development between home and host countries, this difference will determine the size of both the technological gap between each country’s companies and the absorptive capacity of domestic firms. Thus, a technological gap can be defined as the disparities between the technologies and human capital resources of home and host countries’ firms (Jacob and Groizard, 2007). Absorptive capacity, according to the definition above, will provide the ability to adopt available knowledge and to apply it in order to create new knowledge and new competencies (Cohen and Levinthal, 1990; Narula and Marin, 2003).

These definitions implicitly suggest a complementary relationship between backwardness and absorptive capacity. Findlay (1978) notes that the greater the backlog of available opportunities the greater the pressure for change within the backward region. In other words a larger economic distance between home and host countries will increase the chance for spillover effects. However, to increase the chance of spillover effects, a minimum level of absorptive capacity will be required. In other words, the technological distance between the two countries should not exceed a critical level. To conclude, the critical level of technological gap is essentially determined by the complexity of foreign technologies, as well as the extent of and the increase in market penetration by foreign companies (Perez, 1997).

In the banking sector this relationship is valid on condition that the terminology “technology” is adapted. In heavy industry, the term technology refers to machinery’s hard technology that includes equipment and industrial processes. Soft technology largely available in the banking sector would refer to know-how and management competencies, technical, professional and other qualifications (UNCTC, 1989). This definition is confirmed by Romer (1993), who defines the idea of a gap that includes a technology gap as value-generating activities such as marketing, distribution, payment and information systems, business processes, quality controls and staff motivation. From this broader definition and by analogy it can be established that hard technology in the banking sector can be matched to information and communication technologies whereas soft technologies would include business

experience, management, financial and marketing competencies, and technical skills. Patents or intellectual property rights do not protect these competencies because they are mostly embodied in individuals (Grosse, 1996). Similarly, a technological gap in the banking sector will refer to the differences regarding applications of bank-specific information and communication technologies as well as a knowledge gap (Hau and Evangelista, 2007) that refers to gaps with regard to soft technologies (for example managerial gaps and skills gaps). Applying the above technological gap theory would mean that the condition to reduce the knowledge and technological gap between domestic and foreign banks resides in the diffusion of management methods, skills and technologies (information and communication technologies). And similar to the industry case, the extent to which spillovers take place will depend on the size of knowledge and technological gap. Furthermore, a smaller gap would indicate a higher absorptive capacity of domestic banks; however a bigger gap would reduce the ability to learn. In other words more absorptive capacity helps the domestic banks to catch up with foreign competitors, but too big a difference not only in terms of management practices and skills of staff but also in terms of ability to implement technologies could weaken absorptive capacity and reduce spillovers to the advantage of the foreign banks. A large knowledge gap may reduce the efficiency of domestic banks and would result in a crowding-out (Uiboupin, 2005). In addition (and this may apply directly in the case of this SA study) if foreign banks operate in segments that domestic banks are not present or specialised in, such as for instance export financing or export-oriented domestic companies, then the presence of the foreign banks will have a very limited effect.

In SA, the re-entry increased competition in the domestic banking market and contributed to the modernisation of banking capabilities. In 2010, the number of foreign bank branches and foreign owned-banks, which represent 63% of the total banks in SA, surpassed the number of domestic SA banks. The growing number of foreign bank branches and foreign ownership in the banking sector raises the question of the effective role played by foreign banks in the most important African economy. Therefore it is reasonable to analyse the effect of the foreign banks on the domestic banks in SA.

2.1.3 FDI Spillovers and competition due to foreign banks entry and domestic