Why Do Banks Go Abroad? Evidence Using a Three-Way Error Component Model

Abstract

This paper examines whether a host country's bank-capital-to-asset ratio andinternet capability affect inward banking FDI. To do so we develop a two-asset portfolioselection model to analyze the risk-return factors in banking FDI. We then employ athree-way error component estimation model to account for time fixed effects as well asunobserved source- and host-country heterogeneity. The investment activities of 1156banks from 20 source countries into 108 host countries over the period of 2000 - 2008indicate that low bank-capital-to-asset ratio, better telecommunications infrastructure,strong bilateral trade, and the host's economic and financial sector development increaseinward banking FDI. Finally, increased source-host geographic distance and the sourcecountry's government effectiveness affect banks' international investment activity. (C13,F21, F23, G11)