analysis of canadian and mexican banking strategies in the u.s

Analysis of Canadian and Mexican Banking Strategies in the U.S.

Arvind Mahajan and Peter S. Rose*

ABSTRACT

This article reviews regulations and commercial banking structures in Mexico, Canada and the U.S., and examines the comparative operations of Canadian and Mexican bank affiliates in the U.S. vis-a-vis each other and also with U.S. commercial banks of comparable size serving the same markets. Results obtained regarding significant differences in the operations of these banks appear to be consistent with the nascent FDI theory of multinational banking. International survey results regarding bank managers' perceptions and decision criteria suggest that this variable should also be incorporated in the evolving theory.

Large commercial banking organizations in Canada and Mexico invaded the Unites States' financial marketplace decades ago and, more recently, have been greeted by major US bank and non-bank financial conglomerates entering Cana- dian and Mexican home markets in increasing numbers and intensity. The theory of multinational banking operations (Aliber, 1976; Grubel, 1977; Fieleke, 1977; Gray, 1980; Giddy, 1983; Swoboda, 1982) is evolving along the same lines as recent models describing expansion by multinational commercial and industrial corporations. Multinational expansion, regardless of product line, is viewed as a form of foreign direct investment (FDI). Such foreign investments can be explained within a conventional expected return-risk model supplemented with the comparative-advantage paradigm derived from international trade theory. Ex- pected returns from multinational bank operations will be enhanced and/or risk reduced where there are comparative advantages in host- or home-country banking relationships or public policy, economies of scale or scope, effective service differentiation, input or output market imperfections, management quality, research and development programs, and so on. Besides these factors identified by the FDI theory, a few others (although not uniquely different from those above) have also been suggested in the international banking literature, but from a country-specific viewpoint. The General Accounting Office (1979), for example, suggested the following reasons for the rapid influx of foreign banks into the US in recent years: foreign banks followed their foreign business customers to the US; the US dollar's role as a world- preferred medium of exchange; the comparative size and scope of the US market; relatively attractive investment opportunities in the US; and new state banking laws liberalizing foreign bank entry. Terrell and Key (1977) emphasize foreign banks' desire to develop a retail banking business in the US, including appealing to specific ethnic groups of customers. Very few studies have attempted to evaluate these issues empirically. Fieleke (1977) examined reasons for US commercial bank expansion in various countries. He found US FDI abroad as a major factor creating a need for US banks to finance the business activities of non-bank US firms operating in the host country. Besides the need to finance US overseas trade and the rate of expansion of the domestic US banking business, Goldberg and Saunders (1980) also found

* Assistant Professor of Finance and Professor of Finance, respectively, at Texas A&M University.

10 Asia Pacific Journal of Management Vot. 3 No. 1 September 1985

regulation to be major determinant of US bank expansion into the United King- dom. While US regulation was found to be significantly constraining on foreign bank activities, British regulatory policy, while seemingly restrictive, was judged to be limited in its practical effectiveness.

A later empirical study evaluating foreign banking growth in the US between 1972 and 1979 by Goldberg and Saunders (1981) found the following factors as influential: the size of the differential between US and foreign interest rates; the behaviour of P/E ratios for US bank stocks which generally declined over the study period; the increased size of (net) FD! in the US; the exchange rate of the dollar vis-a-vis other convertible currencies; and the expectation of a restrictive effect from the International Banking Act (IBA) of 1978 on foreign banking activity in the United States. In the same year Dean and Giddy (1981) evaluated Canadian bank growth in the US and found the lending spread (i.e., the difference between the prime rate and the commercial or finance-company paper rate) and international trade (measured by the ratio of Canada's exports plus imports to GNP) as significant determinants. Similarly, Terrell (1979), in evaluating Japanese banking activities in the US, found growth in both Japan's foreign trade as well as in US banking markets as significant influences on their entry into the American market. However, Terrell explicitly noted that his results were only suggestive because other factors, such as managers' objectives and decision criteria, were not embodied in Terrell's model. This particular limitation applies to all the empirical studies reviewed above.

The foregoing discussion suggests that a theory of multinational banking is evolving, though it is still in its infancy. Despite the paucity of empirical research, evidence obtained so far appears to tentatively support parts of this theory. In general, growth of foreign banking in the United States has been shown to be related to foreign and US banking regulations, foreign direct investment (FDI) in the US, the growth of foreign countries' trade with the United States, differential exchange-rate and interest-rate movements, and the rate of expansion in domestic US banking markets.

The objective of this paper is to empirically shed further light on the factors influencing cross-country banking by evaluating Canadian and Mexican banking activity in the US. While the theory of FDI explicitly recognizes firm-specific and/ or country-specific comparative advantages as an inducement for foreign expansion, empirical studies heretofore have not evaluated and compared the activities of two foreign countries' banks in a third country to determine if such comparative advantages are apparent in individual-firm behavior. Consistent with the FDI theory, this paper hypothesizes that if country-specific factors (advantages) exist, these will lead to differing activities by the banks of two different countries when operating in a common host country - they will tend to concentrate in different segments of the host country's banking sector.

The first part of the paper provides a brief overview of the recent regulatory changes and the prevailing legislative constraints within which foreign and domestic commercial banks operate in Mexico, Canada and the United States. The next describes the data and methodology employed and presents empirical results of aggregate Canadian and Mexican bank activity in the US. The authors provide an assessment of Canadian and Mexican banks at the individual bank level by pairing them with a US bank of comparable size and location, before presenting results obtained from a survey of large multinational banks headquartered in Mexico, Canada and the United States. These results proxy the "managerial factor" and reflect managers' perceptions of financial markets and regulations in the three countries, the decision criteria they utilize, and their goals and performance targets. Finally, we explore the utility of our results for the management of multinational banks and for public policy.

Asia Pacific Journal of Management, September 1985 11

REGULATORY ENVIRONMENT

Banks affect the size and rate of growth of the money suppsy by issuing liabilities that are near substitutes for money (Gurley and Shaw, 1980; Feige and Pearce, 1977). They also influence the volume and composition of economic growth in different sectors of the economy by allocating credit toward its most profitable uses. To assure that money supply growth and capital allocation are consistent with their broad economic goals, monetary authorities in Mexico, Canada and the United States have imposed restrictions in varying degrees on the operations of their banking sectors. Such regulation, on the one hand, defines the parameters within which these institutions must operate and, on the other, frequently shelters them from external competition. Thus, banking regulations frequently are frac- tured or segmented, often being more restrictive for financial institutions with foreign ownership or affiliation as opposed to those controlled by domestic interests. In the paragraphs that follow we briefly examine recent changes in banking laws and regulations, first in Mexico, then in Canada, and finally the United States.

Recent Banking Developments in Mexico

Historically, the federal government has played a dominant role in Mexican banking, allocating scarce credit resources toward high-priority sectors of the domestic economy. The nationalization of 31 private banks in 1982, controlling more than four-fifths of domestic peso deposits, has further increased the central government's control over the Mexican banking sector. The presence of foreign banking organizations inside Mexico's territory, in the main, has been through the representative-office vehicle, which cannot accept deposits or grant loans denominated in pesos. Nearly 50 years ago, in the midst of the Great Depression of the 1930s, Mexico blocked the establishment of full-service offices by foreign banking organizations. Domestic regulations have not prevented the creation of "near-bank" financial corporations, however, and these are active today in providing business credit and equipment leases. US bank representative offices are more extensive, however, than non-bank financial companies and number more than 30 today. Mexico prohibits foreign investment in established domestic banks, presumably to stimulate the growth of an active national financial marketplace and of institutions that will sell financial services locally. In contrast, Mexican bank penetration of US financial markets is not prohibited, even in full-service form. As of year-end 1984, there were nine Mexican banking agencies, operating out of either New York City or Los Angeles, and most of them were "grandfathered" by the US International Banking Act of 1978. Two US commercial banks located in La Mesa and Los Angeles, Califomia were reported as being majority-owned by Mexican banking organizations. These Mexican-owned or Mexican-controlled US facilities were linked to six major banking and financial-service organizations headquartered in Mexico - - Banamex, Bancomer, Banca Serfin, Comermex, Banco Internacional, and Banco Mexicano Somex. All have established IBFs in the US pursuant to guidelines established by the Federal Reserve Board at the close of 1981.

Recent Canadian Developments

Canadian regulation of the banking sector historically has drawn sharp distinc- tions between the large domestic-chartered commercial banks (which now number 13) and the hundreds of smaller non-bank financial institutions. The chartered banks still dominate the Canadian financial system, holding about three- fifths of att financial industry assets and operating nearly 7,100 branch offices in more than 1,700 communities. In contrast, other depository institutions (principally trust companies, caisses and credit unions) hold about 15 percent of finan-

12 Asia Pacific Journal of Management, September 1985

cial industry assets, while insurance companies, security dealers, sales finance companies, and other financial intermediaries account for most of the remaining 25 per cent of industry resources, though, as Guglietmin (1985) observes, these financial-industry shares move much closer to relative parity when assets controlled (but not owned) by trust companies and insurance firms are included and foreign-currency assets of the domestic chartered banks are excluded. In 1980 changes made in the Canadian Bank Act significantly reduced traditional demarcations between various types of banks and other financial institutions. The revised Bank Act permits Canadian near-banks (holding about one-third of atl banking assets) to convert to operating commercial banks under specified conditions. However, it is doubtful that many near-bank financial institutions in Canada will convert to commercial bank status due to a shortage of management personnel, more lenient provincial regulations, and favourable reserve requirements and tax treatment still accorded non-bank intermediaries. Recently the Canadian governmment proposed further changes in banking laws that would permit greater flexibility in bank ownership and control. Moreover, non-bank financial institutions could set up financial holding companies (FHCs) in order to diversify their services (especially in the commercial credit field) and the scope of their operations, including possible ownership of new (schedule C) banks and non-financial companies. Canadian regulations, historically, have severely restricted foreign bank entry into the domestic market. However, the revised Bank Act now allows foreign banks to apply for operating licenses which permit a full range of commercial and consumer banking services to be offered, subject to capital-ratio restrictions. By the end of 1984 58 foreign banking organizations had secured federal licenses, led by the largest US multnational banks. In brief, many of the organizational and competitive changes occuring today in the US banking industry are also evident in Canada. There is continuing proliferation of financial-service firms from both domestic and foreign sources, adding a new dimension to financial-market competition in domestic markets. Canadian bank intrusion into US financial markets is extensive and has been an active trend for most of this century due to growing needs for short-term liquidity, long-term capital, and the financing of international trade which represents over one-fourth of Canada's GNP. At year-end 1984 there were 15 agencies of Canadian banks registered in the US headquartered in New York City, Coral Gables, Miami, Atlanta, Santa Ana, Los Angeles and San Francisco. Another 21 branch offices were operating in Boston, New York City, Pittsburgh, Chicago, Beaverton, Portland and Seattle. In addition, 16 US banks were majority-owned by five Canadian chartered banks. In total, 10 leading banking and financial-service companies in Canada controlled more than 30 financial-service corporations inside the United States. Of particular importance in Canadian markets is the developing trend among securities firms (including those operating as affiliates of US securities firms) to establish themselves as financial-service companies and offer bank-type services. American-based financial-service firms (such as Shearson-American Express and Citibank) recently have announced their intention to acquire minority interests in Canadian securities firms. Ultimately, Canadian securities firms may become major competitors with banks in the market for combined checking- account, brokerage services and more aggressively pursue cash-management, insurance, and retirement-plan accounts.

Recent Developments in the United States

Within the United States the regulations distinguishing domestic commercial banks from other domestic financial institutions were drastically changed with the


passage of the Depository Institutions Deregulation and Monetary Control Act (D!DMCA) of 1980 and the Garn-St Germain Depository Institutions Act of 1982. Briefly, these new laws have significantly reduced the differences between US bank and non-bank depository institutions m especially in terms of deposit reserve requirements, interest-rate ceilings on thrift deposits and interest-bearing transactions accounts, usury laws, and asset portfolio composition. These new laws have had a profound impact upon US commercial banks in terms of increasing competition from other domestic non-bank financial institutions.

However, some protection from foreign bank competition was provided by the International Banking Act (IBA) of 1978 whose basic intent was to bring foreign banks under the same geographic, operating and financial constraints as domestic banks. IBA embodies the principle of "national treatment" by bringing the agencies and branches of foreign-based banks under federal supervision and subjecting them to US bank reserve requirements, deposit interest-rate ceilings, and inter-state branching restrictions. US multinational banks were further aided by federal authorization of domestically based International Banking Facilities (IBFs), beginning in 1981. The Federal Reserve System created this new institu- tional book-keeping facility in an effort to attract a greater share of what were for- merly off-shore banking operations back to the United States (Dunham, 1982; Baker, 1982; Chrystal, 1984; White, 1982; Key, 1982). Partly in response to growing foreign-bank competition, the structure of US banking continues to drift toward larger multiple-office organizations, spurred by market-spanning improvements in communications technology and increasing competition for both funds uses and funds sources from a growing spectrum of financial-service firms. Sears Roebuck, Merrill Lynch, Transamerica, Shearson- American Express, Kemper Corporation, and the PrudentiaI-Bache alliance of insurance and brokerage units represent just a few examples of financial-service firms that have entered traditional bank product lines, especially commercial and consumer lending and payments services. This last development is perhaps more pregnant in its implications for the future of US banking than any of the other structural trends noted above. One reason is that the largest US banks have begun to take the diversified financial-service company route themselves in response to the growing penetration of bank product lines by new financial- service companies. Through their holding-company organizations, for example, the top US banking organizations are entering the brokerage and investment business (e.g., the affiliation of Bank America with Charles Schwab & Co.) and savings banking (e.g., Citicorp's acquisition of Fidelity Savings of San Francisco). These market and regulatory trends indicate the breaking down of historic bar- riers between bank and non bank institutions in the United States. It is the most recent phase in a broad trend in the financial-services industry towards "financial department stores ~, blurring the traditional separations between established financial industries and encouraging national and state governments to gradually deregulate the financial sector.

ANALYSIS OF CANADIAN AND MEXICAN BANKING ACTIVITIES IN THE UNITED STATES

As the foregoing discussion suggests, banks chartered in Mexico, Canada and the United States face markedly different competitive and regulatory regimes at home. Each has entered US financial-service markets with diverse backgrounds and presumably with motivations influenced by both market background factors and the regulatory environment. A recent study by Goldberg and Saunders (1981) implies that domestic regulation is a key factor in shaping a domestic banking organization's approach for entry into foreign markets. If valid, we may infer that Canadian and Mexican banking activities in the US will display important differences in portfolio composition - a reflection of differences in both their domestic


regulations and domestic economic advantages, in this section we wish to explore the hypothesis that foreign-bank operations in a common market (in this case, the United States) still differ significantly based upon country of origin. With the operating environment of the US held constant for both Canadian and Mexi- can foreign operations, differences observed in the US activities of these banks may reasonably be ascribed to home-country factors. Data reflecting the financial-statement characteristics of major CanadiAn and Mexican banking organizations operating within US borders were secured from the Federal Reserve Board. The data received from the Board encompassed complete Reports of Condition for 10 Mexican banking organizations and 36 Canadian banking institutions. This data was supplemented by more recent call report items through 1983 for foreign bank entities from the consolidated banking tapes of the three US federal bank supervisory agencies. In total, the available data for the 46 foreign-based bank corporations mentioned above covered a three and a half year period from the June 1980 Condition Report through year- end 1983. TABLE 1 provides information on asset and deposit portfolio mix over the study period for all Canadian and Mexican US bank facilities. Because the table is self-explanatory, the discussion that follows highlights only the major differences between each nation's US-situated banking activities.

Asset Portfolio Mix

The left-hand (asset) side sheds light on the asset composition (as a percentage of total assets) for the Canadian (columns 2 to 5) and Mexican (columns 6 to 9) banks for year-end 1980, 1981, 1982 and 1983. A major difference between these banks can be observed in their participation in the real-estate loan market. Whereas real-estate loans comprised more than one-fifth (22 per cent) of the Canadian banks' total assets, these loans were less than one per cent of total assets for the Mexican banks. On the other hand, Mexican banks were much more active in providing loans to financial institutions (located in the US as well as to banks in foreign countries) than the Canadian banks. The same was true regarding loans to foreign governments and other official institutions. Canadian bank participation in the personal and household market represented about 1.5 per cent of their total assets, while Mexican banks virtually abstained from this market. Total commercial and industrial (C&I) loans were the predominant credit component for both Canadian (averaging 46 per cent over the four years) and Mexican (averaging 41 per cent) institutions operating in the US. While for Canadian banks this proportion was stable, Mexican banks' C&I loans fluc- tuated widely over time3 Moreover, a fundamental difference is observed in the Canadian and Mexican banks' operations when total C&I loans are segregated by addressees. On average, Canadian banks' US offices reported about 43 per cent of their total assets as C&I loans to US addressees and less than 3 per cent to foreign addressees; whereas Mexican bank offices' C&I loans were virtually all to foreign addressees. In summary, an analysis of bank asset mix suggests that the focus of the Canadian banks in the US as been on the domestic loan market and their policy towards portfolio composition has been relatively consistent. On the other hand, Mexican banks' US activities channel a significant portion of their available funds to foreign customers (including their home country) and, in general, display an unstable investment portfolio pattern.

Liability Portfolio Mix

The right-hand side of TABLE 1 gives different liability items (expressed as a percentage of total assets) for the US offices of Canadian and Mexican banks for


TABLE 1

Selected Assets and Liabilities of US Branches and Agencies of Canadian and Mexican Banks as

a Percentage of Total Assets for Year-Ends 1980 to 1983

Canadian Mexican

Assets 1980 1981 1982 1983 1980 1981 1982 1983 (1) (2) (3) {4) (5) (6) (7) (8) (9)

Cash&DuefromDepositlnst. 7.84 6.00 5.30 5.39 8.76 6.21 0.33 0.34 USTreesuP/Sesunties 0.50 0-83 0.77 2.30 0.13 0.14 0.19 0.29

ObLofOtherUSGov't 0.04 0.53 0.03 0.00 0.00 0.00 0.00 0.130 Agencies & Corporations

ObLofStetes&Pofiticat O.OO 0.00 0,00 O.O0 0.00 0.00 O,O0 O=O0 Sub-divisions in US

AliotherSesurities 0.28 0.17 0.15 0.10 0.05 0.06 0.14 0.10 Federat FunrJs SOld &

Secs. purchasedUndor &22 2.81 1.43 2.46 3.30 10.02 0.61 4.00 Agreemell{ tO Re~ i

Real Estate Loans 21.55 21,29 30.96 18.87 0.77 0.66 1.06 0.96

Loans to Oommercial 0.95 0.74 1.50 0.55 9.87 5.32 0.32 0.17 Banks in US

Lomls tO 8esks in 1.26 1.23 0.73 0.29 7.25 4.20 5.0t 3.01 Foreign Countries

Loans to Other 0.88 1.07 0.82 1.31 0.00 0.19 0.63 0.91 Financial Inst.

Total Loarsto 3.09 3,04 3.02 2,15 I7.14 9.70 5.96 4.00 Financial inst.

Loons for Purchesing 0.76 0.91 0.48 0.40 0.00 0.00 0.00 0.130

Loans to Non-US Addressees

Total Commercial & Indust. Loans

Loans to Individuals for Household. Family & Other Personal Expenditure

Lo~s to Formg~ Gov'ts & Other Official institutions

Total Loans (esci. unearned income On loans)

Other*

Liabilities (10)

Canadian Mexican

1980 19811982 1983 1980 1981 1982 1983 (11) (12) (13) (14) (15) (16) (17) (18)

OemandDepositslPC 4.96 4.55 3_75 4.06 0.00 0.00 0.00 0.00 US (Addressess)

DemandDepesitsiPC 0.38 0.41 0.56 0.80 0.00 0.00 0.00 0.07 (Non-US Addressee)

Demand Deps.-Fargn. 0.0O 0.01 0.00 0.0O 0.00 0.00 0.00 0.00 Govt's. 8, Off, inst,

DemandDeps.-Banks 0.03 0.03 0.05 0.10 0.00 0.00 0.00 0.00 in Foreign Countries

Total Demand Deposits (incl. 7.69 6.15 5.17 5.76 6.49 0.63 0.01 0.16 other categ, not above)

Savings Deps. IPC (US Addressees)

Savings Deds. IPC (Non-US A~ressees)

Savings Deps.-Forgn. Govt's. & Off. Inst.

Savings Deps.-Banks in Fore'.gn Countries

Tota~ Savings Deposits (incl. other categ, not above)

Time Deps. I PC or Carrying Securities Loans to US A d d r ~ " ' s 44.46 44.834293 4130 0.12 0.12 0.52 0.02

2.50 2,85 3.09 2,48 36.34 45.08 40,03 39.54

46.96 47.88 46,02 43.98 38.46 45.17 40.55 39,57

2.52 1,50 1.5 0.89 0.01 0,01 0.03 0.03

0.68 0.20 0.04 0.30 9,42 14.94 18,15 34.20

77,14 75.92 74.30 68.98 68.71 70.53 6&39 79,79

10.98 13.74 1&02 20.77 18,98 13.04 32.34 15.57

(US Addressees) Time Oeps. IPC

(Non-US Addressees) Time Deps.-Foreign

Govt's. & Off. Inst. Trine Depa,-Banks

in Foreign Countries Total Time Degs. (incL

other categ, not above) Time Certificates of Deps.

($t00,000+) Total Deposits & Credit Bats.

of US Gov't & of State & Political Sub-div. in US

Total Deps. & Credit Bat. of Banks in Foreign

Countries TOt~ Credit Balances Total Deposits and

Credit Balances Fed. Funds Purchase Other Liabilities for

borrowed Mor '~ Branch or Agercy Liabilities

ort Acceptance Execute¢~ & Outstanding

Other L~abilities to Nonrelated parties

Net Due to Head Office arid

1.36 0.99 1.03 1.00 0.00 0.00 0.00 0.00

0.31 0.15 0.18 0.34 0.00 0.00 0.00 0.00

O.00 0.00 0.00 0.00 0.00 0.00 0.00 0.0O

0.00 0.00 0.00 0.01 0,01 0.00 0,00 0.00

1.68 1.13 1.21 1.38 0.00 O.00 0.0O 0.00

14.39 15.29 14.67 16.11 0.00 0.00 0.00 0.00

4.41 7.40 I%22 16.78 2.71 2.79 0.77 0.07

1.02 0.38 1.91 0.43 0.03 0.00 0.00 0.50

0.01 0,21 0.19 0.80 0.00 3.27 17.07 19.80

20.42 23.74 29.04 35.27 2.74 6.27 4426 54.15

12.27 t5.72 17.76 20.77 2.64 2.58 0.07 0.00

0.30 0.44 0.70 0.36 O.OS 0.00 0.00 O.OO

0.50 0.55 0.35 1.00 0.00 3.28 17.07 19.80

2.92 0.86 0.45 0.43 0.0t 0.12 0.04 0.09

32.71 31.89 35.88 42.81 9.24 7.03 44.30 54.40

3.98 4.94 7.30 2.21 16.69 14.89 1.19 0.30

10.35 17.23 17.37 10.54 57.56 63.47 37.50 30.05

2.26 2.65 2.27 2.33 0.B9 1.83 0.26 0.91

1,06 t.48 1.29 1,14 1.48 2,&3 2,09 1,54

Other Related lnstitt~ons in 49.63 41.80 35.89 40.98 14.15 10.45 14.56 13.71 US and in Foreign Countries

° Includes lease financing recalval:~es; bartk premises, furniture, fixtures and other assets: real estate Owned other than bank premises: and all other assets.


year-end 1980 through 1983. On average, Canadian banks held a slightly higher proportion of their deposits in the form of demand accounts during 1980 than did Mexican institutions. However, both groups' demand-deposit holdings declined during 1981 and 1982, perhaps due to increased competition for these deposits by non-bank US financial institutions following passage of DIDMCA in 1980 and major policy actions directed at financial deregulation. For example, Mexican banks' demand deposits dropped from 6.49 per cent in 1980 to 0.63 per cent by year-end 1981 and only 0.01 per cent in 1982, probably reflecting depositor con- cerns over economic and financial pressures inside Mexico. In all four years Canadian banks attracted a majority of their deposits from US domiciled individuals, partnerships and corporations (IPCs). Mexican banks, in contrast, did not report deposit gains from these sources.

As is true of comparably-sized US banks, time deposits constitute the most important source of deposits for Canadian banks, a majority again belonging to US domiciled IPCs. Mexican banks' share of this market was much smaller during 1980 and 1981, but showed a substantial increase in 1982 and 1983 (predominantly due to an increase in deposits from banks in foreign countries). Simi- larly, while Canadian banks actively used large ($100,000 plus) negotiable CDs to raise funds, and there is a clear upward trend in their usage of money market CDs over the period of the study, this constituted a much smaller and a steadily declining source of funds for Mexican banking offices in the US. In fact, by 1983 no Mexican bank was participating significantly in the US CD market, at least as reflected in their Reports of Condition. 3 The predominant (albeit declining) source of funds for the Mexican banks was branch or agency liabilities on acceptances executed and outstanding, averaging 47 per cent over the study period. For Canadian banks the comparable ratio was less than 14 per cent. On the other hand, the most important source of funds for the Canadian banks was net deposits due to the head office and other related institutions in the US and in foreign countries, averaging 42 per cent for the 1980-83 period, while this source averaged only 13 per cent for the Mexican banks. In summary, despite some portfolio commonalities, Canadian and Mexican bank activities in the US are significantly different in the composition of their sources and uses of funds, both in terms of trend and magnitude.

COMPARISON OF CANADIAN AND MEXICAN BANKING AFFILIATES PRESENT IN THE US WITH COMPARABLY SIZED US BANKS

The foregoing analysis brings out the major differences in mean portfolio composition between Canadian and Mexican bank affiliates and subsidiaries operating in the US. If the theory of foreign direct investment (FDI) is valid and firm - and country-specific factors (such as comparative advantages or regulations) are the raison d'etre for foreign organizations to penetrate specific segments of the host country market, then we should expect significant differences in the activities of foreign banks vis-a-vis similar host country banks. White (Terrell, 1979) and the GAO (1979) studies suggest that foreign banks follow their parent- country corporations to the host country. Even in this case, to the extent these corporations were instigated to expand abroad due to unique firm- or country- specific economic factors identified by foreign direct investment theory, our hypothesis that foreign bank activities will differ from those of domestic banks will still hold. In this section we test the above hypothesis by extending the analysis to the individual bank level, seeking to determine the extent to which Canadian and Mexi- can bank activities in the US differ from those of domestic US banks, parallel in size and location. Several large US commercial banking organizations were

Asia Pacific Joumal of Management, September 1985 17

TABLE 2

Differences in Portfolio Composition Measures for Paired Canadian-US and Mexican-US Banks Operating in the US, Year-End 1980, 1981, 1982 and 1983

CANAI~AN ANO US BANK PAIRS

MEAN RAt30 MEAN RATE) ~ 0 M~N RAT.3 DIFFERI~NCE D~FFERENCE DIFFERENCE O IFF~ PORTPOUO COMPOSmON

MEASURE (AS A PERCENTAGE OF TOTAL ASSETS) Rc~ rr~nu~s Ru~ R~ rrunus R~ F I~ minus Fl~ R~ minus R~

(I) (~ ~) (4) {5)

Asaet=

CaSh & ~ ~-orn D~p. ~ t , -10.05 = -11 ~0 = - ;161" - ~4.0t" Fed, F~ SO~ &Sec. Pmc~

u~e r Ag~em. z~ R~ -3.86 -3.40 -3,55 = -1.33

Real EState Loans 4,33 5.24 0.25 5.29 to Comm. Banks. - US 0.26 o.01 0.47 -0.69

t.oa~s to Banks. in For. Cot;n 0,80 0,08 0.30 -0.40 Loans to Other Fie, an. Inst. 0.42 0~58 -0.20 0,18 Total Loans to Finan. Inst, 1.45 1.14 0.48 -0,93 Loans fc~ Push & Camping -9.33 0.23 -0.39 -0.69

Secur~=es C~ L~a~s ~o US A~d,essees 27,21 ~ 21.50' ll.8~ 10.39 C&£ LOar~s to Non-US .4.54 -4.47 -3.38 -3.06

Ao~essees Comm, & Indust, (C&I) Loans 29,03. 24.71 = 24.07, 19.48' Loarts to InOiv~iuals (or

HShld. Faro. & Otl~e~ - 7.30" -8.10 ~ -7.60" -7.49" PeP~?A~-~ ~d i l ~6S

Lo~S to For, Gov'ts & Of f ~st. -2.55 -2.07 ~ -3,{)6 -3.~5

Tot'~ Loans ( e~ . upper ~ 20~51" 24.34= 22.95* 16.7~ I ~ncome~

Dem~ ~ps . of For. Gov'ts. &Off. ~nst. -O.2O -0.03 ~.39 ~.02

Demand 0e~s. of ~ks ~n "O,41 ~.40 -O.t I -0.20

Total O6.mat~t DeD~ ('m c~, -20.64* - 18.62" -15.17" *14,40" oev~ cat. bes~es ab0ve)

Sa~ r~ Baps. fo~ For. G~v't¢ & Off inst. 0.00 0.00 ~.30 -0.30

Sa~ngs ~ps . of Ban~s ~n F¢~. ~ 0.30 0,00 -0.30 -0.00

TO¢~ S,~¢ings Oep. ~ *11.9~ - l l . l tP - i4.01" -16.75 =

Time Dep~ of Fo¢. Gov'ts & Off, ~ 0,35 -0.40 1.29 -0,23

Time OeOs. of BanKs in FOr, C ~ "0.2,3 0.0~ -0.41 0.45

T°¢~ *rl/rm Del~" ('~IcL -14 .~ '~ -14,51' 13.~1 a -1.28 o~le¢ caL beek~s above)

Tm~e CD's ($t00,030+) ~1,27 -4~7 -5.91 -0,41 Tot~ Dep¢ & Cr. 8~ of ~O.Z8 -O.O7 -0.~0

FeB, FU l l ; Pur~ . & Se~ Seid LmBar Agmen~ to -2~52 -2.88 -0.79 -T.OIP R~.

Otter Ua~ fo~ ~ Money 9,06 = 17,9~ 16.49 = 10.42

~ Executed ane ~atstm<¢~ l . e~ 2~2 t.Td' 1,8P

MEXICAN AND US BANK PAIRS

1980 198t 1982 1083 MEAN RAT, O MEAN RATIO MEAN FU~T~ MFJ~ RAl lO OtFFEF~NCE OH~FE~NCE ~FFERENCE DIFFERENCE

R~ m=l~.~ Rus R~ r~rcLs R~ B~ minus R~ R~ mL~US Rus

16) (71 (8)

-5.75 -9.51 -17.23" -10.93,

4 .39 -1 13 *9.74 .1.66

"14.8~ '= -14,11 a ~1~ ,~ "12.47" 9 87 £,4.82 ~ 0,32 0.01 7.22 ~ 2.15 2,40 ~0,60 -0.35 -0.09 0.35 0.69 13,76 6.86 3.07 0.10

~.04 -0.08 -0.03 -0.03

-39.9t -Z8.55= ~2.25= -17.4~

3.45 50.46 52.42P 57,05

14 12 2508 10.70 21.56

-g.SP -6 ,~ -8138, ~7 . ~

26398 4 04 17.39 ~0,94

7548 20.5~ 2022 36.45"

-0.30 ~).30 -0.01 -0.00

-0.47 -z.19 -O.C~ @.06

-26.9e = -28.85= -25.43, -22.92"

0.30 0.00 0.30 0,00

0.30 0.30 0.00 0.00

0 .~ O.30 0.30 0.57

0.GO 3.74 16.93. 20.03'

-30.13" -28.18" 9*94 23.02*

-17.75= -t9.C~' -18.04" -15J~ t

4 .47 2.56 16.90 1+9.~9"

12.4.6 11,18 -3,01 7 ,49

57.15 = riO.g4' 37.0P 31,92 ~

0.8,r~ 1.08 0.30 -0,45


selected for comparison purposes with each US bank chosen matched with the Canadian or Mexican banking organization domiciled in the same city and closest in the magnitude of total assets. The authors were able to successfully pair 29 Canadian and US banking organizations in 1980 and 1982, 31 in 1981 and 25 in 1983, while successfully paired Mexican and US banks numbered seven in t980 and 1983 and eight pairs in both t 981 and 1982. Standardized dependent- sample t-ratio statistical test of reported financial ratios, reflecting the consti- tuency of loans, deposits, and money market borrowings, were carried out through year-end 1983. The calculated financial-ratio differences are shown in TABLE 2 and those significant at the one (a = 0.01) and five ((z= 0.05) risk levels are identified.

Statistical analysis revealed a number of significant differences in sources and uses of funds between foreign Canadian and Mexican banking offices and comparable US domestic bank offices. For example, on the asset side of the balance sheet paired US banks reported substantially higher proportions of cash assets - principally interbank deposits subject to immediate transfer- than both groups of foreign affiliated offices. Mexican banks had a significantly lower proportion of real estate loans than their US paired banks, while Canadian banks were only somewhat more active than their US counterparts in the real estate credit field. Canadian and Mexican banks, in general, were much more active in the commercial and industrial (C&I) loan market than similar US banks. However, while Cana- dian banks' ratio of C&I loans to US addressees was significantly higher than that of the paired US banks, Mexican banks' commercial-loan ratio was significantly lower than their respective US-paired institutions. Although this finding is consistent with Goldberg and Saunders (1981), who identified the C&I credit market as the area where foreign banks provided the most competition to domesic US banks (at least over their test period of 1972 to 1978), our results suggest that foreign competition within various segments of the US credit market is foreign- country specific. Overall, the total loan-asset ratio - a traditional measure of risk and liquidity in banking - was substantially higher for the foreign-based banking affiliates than was true of the paired US banks.

As expected, all major categories of deposits - total demand accounts, aggregate savings, and time deposits - were, in general, significantly lower on the reported balance sheets of both Canadian and the Mexican banks than for their US counterparts. The unavailability of this source of funds for foreign banks is predominantly because of the fact that foreign-bank agency offices cannot accept US public deposits (except in the state of New York), though as White (1982) observes, agency offices hold only about a quarter of all foreign-bank foot- ings in the US. Yet, curiously, while Mexican banks made substiantially more use of federal funds borrowings during 1980 and 1981 than their US counterparts, Canadian institutions made less use of this avenue for short-term credit. Finally in both countries' foreign affiliates, two categories of liabilities - other liabilities for borrowed money, and branch and agency liabilities on acceptances executed and outstanding - were significantly larger than reported by comparable US commercial banking organizations.

The lesser reliance of foreign affiliates on deposits undoubtedly reflects their desire to avoid US regulations regarding deposit reserve requirements, interest- rate ceilings (which were more constraining in 1980 and 1981 than at present), and deposit insurance. For many of these affiliates (particularly those from Canada situated in New York City) it is clear that management regards one of their principal functions as attracting Ioanable funds in the American market in order to support the funding of both foreign and domestic financial services.


RESULTS OF A SURVEY OF INTERNATIONAL BANKING ACTIVITIES AND SERVICES IN MEXICO, CANADA AND THE US

The preceding analysis points to significant differences in US-based activities of Canadian and Mexican banks as well as between these institutions and comparable US banks, all operating in similar markets. These differences seem to justify the existence of country-specific economic and regulatory factors determining the specific segment of the US banking market in which each country's banks conduct their operations. However, no data are available to discern the important differences such as, in profitability, and in business, regulatory and foreign-exchange risks faced by these banks which may influence their decision to penetrate different markets. To determine this, a detailed survey questionnaire was sent in the Spring and Fall of 1983 with follow-ups in 1984 to all $100 million- plus US banks as well as domestically chartered Canadian and Mexican banks. Included in the survey were questions regarding the quantity and quality of banking services offered by each nation's banks in their foreign operations and the perceived profitability and risk of foreign and domestic banking activities. Although the survey results were not expected to shed light directly on the existence of specific comparative advantages, they were designed to reflect different country-specific "managerial factors" and management expectations that may have influenced past strategic decisions and may influence future decisions. Results obtained from the international survey are suggestive of a number of differences in bank activities in performance measurement, and in managerial perceptions regarding problems and trends in Mexico, Canada and the United States.

Ranking of Bank Performance Criteria

Banks participating in the survey were asked to rank in order of importance the criteria they employ to evaluate the performance of their domestic sales of banking services versus the performance criteria they apply to sales of banking services in neighboring countries on the North American continent. TABLE 3 indi-

TABLE 3

Mean Rankings of the Principal Criteria Used by Canadian and US Banks to Evaluate the Performance of Their Domestic and

Foreign Operations in Each Other's Countries

Mean Rankings of Performance Criteria* in:

Criteria for Evaluating Performance

Profitability

Cost Effectiveness and Efficiency

Riskiness Growth Market Share

Domestic Operations

Canadian US Banks Banks

1.0 1.4

2.5 2.8 2.5 2.7 4.5 3.7 4.5 3.7

Financial Services Offered by:

Canadian Banks in

Mexico and the US

1.5

3.0 1.5 4.0 5.0

US Banks in

Canada and Mexico

1.8

2.8 1.9 3.7 4.0

A ranking of "1" is for the most important criterion, and of "5" for the least important. Frac- tions result due to averaging over the responding banks.


cates the mean rankings assigned by Canadian and US banks to the five suggested performance criteria listed on the survey form - profitability, cost effectiveness and efficiency, riskiness, growth, and market share. Major banks in both countries clearly rank profitability as the principal performance criteria for their domestic banking operations, followed by cost effectiveness/efficiency and risk. Growth and market share ranked lowest as criteria for evaluating domestic bank performance. When we turn to sales of banking services in the other two countries, however, risk increases substantially in relative importance. In fact, riskiness is virtually equal in importance to profitability in evaluating the performance of each bank's foreign marketing efforts, with cost effectiveness/efficiency ranked third, followed by growth and market share. The greater relative concern for risk in international banking activities vis-a-vis domestic banking activities, irrespective of banks' nationality, is evident from these survey findings?

Risk Measures in Foreign and Domestic Operations

The survey asked responding banks to rank their measures of risk applied to both domestic sales and foreign North-American sales of banking services. The most consistent and usable responses to this question were reported by US banks which cited marked differences in the relative importance of risk measures applied to banking operations within the US versus US bank acitivities in both Canada and Mexico (see TABLE 4). The highest-ranked risk measure applied by responding US banks to their domestic activities was based upon the composi-

TABLE 4

Mean Rankings of Risk Measures Used by Responding US Banks to Evaluate the Riskiness of Their Service Offerings

in the Domestic Economy and in Canada and Mexico

Criteria for Evaluating Performance

Currency Denomination of Assets and

Liabilities

Nature of Assets and Liabilities

Possibility of Changes in Regulation: (a) by Foreign

Authorities (b) by Domestic

Authorities Changes in Exchange Rates

between US Currency and that of Foreign Operations

Interest-rate Fluctuations in Other North American Countries

Earnings Fluctuations of Foreign Operations

Mean Rankings of Performance Criteria* in:

US Banks' Domestic

Operations

2.6

2,0

4.8

3.5

4.3

6.0

4.3

Foreign Services Offered by US Banks in Canada

and Mexico

2.3

4.5

3.7

6,4

3.2

5.8

4.2

A Ranking of "1" is for the most important criterion, and of "5" for the least important. Fractions result due to averaging over responding banks.


tion of their assets and liabilities. In foreign operations, however, the top-ranked risk measure was the particular currency denomination of bank assets and liabilities followed by relative changes in exchange rates.

Measures of Foreign Currency Exposure

With the advent of the flexible exchange-rate regime in 1973, commercial banks have been concerned with foreign currency exposure for reporting and hedging purposes. Responding banks ranked a number of alternative measures of foreign currency exposure, including accounting translation exposure according to FASB Statement ~,52, accounting translation exposure plus transaction exposure, present cash flows in foreign currencies, present and future cash flows in foreign currencies, and no exposure measure. The highest ranked measure of foreign currency risk exposure was indices of present cash flows in foreign currencies; this currency-risk measure was followed in relative importance by related indices of present and future cash flows in foreign currencies. Methods of estimating foreign currency risk by US banks in consolidated operations and Canadian and Mexican operations were also explored in the survey.

TABLE 5

Comparative Evaluation of the Profitability of Foreign Banking Services Sold in Canada and Mexico with the Profitability of Domestic

Banking Services as Viewed by US Banks

Compared to Their US Operations, American Banks Ranked Their Sales of Financial Services in Canada as:

Percent of All Responses Regarding Profits in the:

Significantly More Profitable

Somewhat More Profitable

About Equally Profitable

Somewhat Less Profitable

Significantly Less Profitable 50.0

Compared to Their US O )erations,

Most Recent 5 Years

0.0%

0,0

28.6

28.6

Most Recent Year

0.0%

12.5

0.0

37.5

42.9

American Banks Ranked Their Sales of Financial Services in Mexico as:

Percent of All Responses Regarding Profrts in the:

Significantly More Profitable

Somewhat More Profitable

About Equally ProfRable

Somewhat Less Profitable

Significantly Less Profitable

Most Recent Year

11.1%

0.0

11.1

11.1

66.7

Most Recent 5 Years

22.2%

33.3

22.2

0.0

22.2


Although six measures were suggested on the survey form, some responding US banks simply observed that "all foreign currency risks are fully hedged". Among the most highly rated currency-risk evaluation methods were making subjective evaluations of foreign currency-risk, estimating probability distributions of cash flows from a loan, and calculating loss probabilities.

Comparing the Short- and Long-Term Profitability of Domestic and Foreign Operations

As shown in TABLE 5, most US bankers ranked their Canadian activities "significantly less profitable" than their US operations. This particular response was top- ranked both for the "most recent year" (short-run) and for the "most recent five year" (long-run) period. Comparative evaluation of the profitability of sales of banking services in Mexico yielded decidedly mixed results, however. In the most recent period a substantial majority (at least three quarters) of the responding US banks ranked their Mexican activities as "less profitable" than sales of bank services in the domestic market. Presumably this adverse rating of Mexican activities was heavily influenced by recent economic and regulatory changes in Mexican banking.

An interesting contrast emerges, however, in comparing the near-term and long- term US bank evaluations of Mexican operations. The modal response (one third of all responses) for the "most recent five years" ranked the profitability of US banks' Mexican operations above their domestic activities. Moreover, nearly three quarters of responding US banks ranked their Mexican operations as either "more profitable" or "about equally profitable" than their domestic sales of banking services for the latest five-year period. This finding may suggest that, until Mexico's recent economic and financial difficulties, many US bankers evaluated Mexican banking markets as offering substantial opportunities for profitable operation, perhaps related to the rapid increase in oil prices in the middle and late 1970s, Mexico's extensive oil reserves, and the significant expansion in tourist trade along Mexico's southern coasts.

Comparative Riskiness of US, Canadian and Mexican Operations

Compared to their domestic operations, responding US banks saw little addi- tional risk from selling their services in Canadian markets (see TABLE 6). A substantial majority (62.5 per cent) of responding US bankers rated their Canadian operations "about equally risky" in the most recent year and three quarters rated their Canadian sales of services "about equally risky" with US banking activities during the latest five-year period. These results contrast sharply with US bankers' comparative weighing of risk in Mexico vis-a-vis their domestic operations. A strong majority (almost 90 per cent) rated sales of banking services in Mexico substantially more risky than domestic sales in the most recent year.

Comparative Growth of Banking Services

US bankers experienced less growth in their Canadian customer accounts over both the short-run (most recent year) and tong-run (most recent five years) compared to their US banking activities. This result is not surprising in view of the strong legal restrictions against foreign-bank penetration of Canadian markets prior to the 1980 Bank Act revisions and, more recently, with federal limits on both foreign bank size and branching activity. Moreover, during the most recent year US bankers saw their Mexican operations growing less rapidly than their domestic activities. However, this was opposite


TABLE 6

Comparative Evaluation of the Riskiness of Foreign Banking Services Offered in Canada and Mexico with the Riskiness of Domestic Banking

Services as Viewed by US Banks

Compared to Their US Operations, American Banks Ranked Their Sales of Financial Services in Canada as:

Percent of All Responses Regarding Risk in the:

Significantly More Risky

Somewhat More Risky

About Equally Risky

Somewhat Less Risky

Significantly Less Risky

Most Recent Year

0.0%

25.0

62.5

12.5

0.0

Most Recent 5 Years

0%

12.5

75.0

0.0

12.5

Compared to Their US Operations, American Banks Ranked Their Sales of Financial Services in Mexico as:

Percent of All Responses Regarding Risk in the:

Significantly More Risky

Somewhat More Risky

About Equally Risky

Somewhat Less Risky

Significantly Less Risky

Most Recent Year

88.9%

0.0

0.0

11.1

0.0

Most Recent 5 Years

66.7%

0.0

11.1

22.2

0.0

from the bankers' long-run view of the growth of Mexican banking activities where a majority (78 per cent) saw the growth of their sales in Mexico outstrip- ping domestic sales over the most recent five years.

Service-Quality Comparisons

Respondents were asked to evaluate the quality of services offered customers in other national countries compared to those same banking services offered domestic customers. The majority of responses centered around comparative equality of service quality among the three countries, suggesting the growing interconnections and interrelationships between the three national economic and financial systems.

The Range of Services Offered in Domestic and Foreign Markets

Responding banks were asked to check which of a wide range of services they offered in the domestic markets and in the other two national markets. Financial services were grouped into six broad categories - deposit services, lending ser-


vices, cash management services, international banking services, fiduciary (trust) services, and other banking services. As expected, the major money-centre banks included in the survey offered virtually all the services listed in domestic markets, but service offerings typically were not as complete in foreign markets. The contrast between service offerings in the US and Canada was particularly marked. Generally US banks offered nearly parallel services in Canada to those they offered inside the United States. The same was true of Canadian bank offerings at home and in the United States. As expected, c o m m e r c i a l s e r v i c e s were more likely to be offered simultaneously in both domestic markets and in neighboring countries. Services typically offered c o n s u m e r s - such as credit and debit cards, installment loans, and personal trust services - were much more likely to be offered at home than in foreign markets.

Evaluation of Domestic and Foreign Regulatory Policies

Participating banks were also asked to evaluate the quality of domestic banking regulations. The responses varied markedly, but tended to be bimodal. Respond- ing Canadian banks and US banks were inclined to check regulation as "generally responsive to industry needs" or "restrictive and unnecessarily confining". The majority of US banks, however, rated domestic banking regulations as "generally responsive to industry needs", undoubtedly reflecting recent efforts by Congress (principally through the Depository Institutions Deregulation Act of 1980 and the Garn-St Germain Depository Institutions Act of 1982) to liberalize banking regulations, especially on the deposit side of the balance sheet and in structural areas such as interstate acquisitions. On the other hand, most Ameri- can banks rated both Canadian and Mexican banking regulations as "restrictive and unnecessarily confining". Canadian banks generally perceived US bank rules as more liberal than Mexican banking regulations. Canadian institutions consistently ranked US regulations as "unresponsive but reasonable", but generally regarded Mexican banking rules as "restrictive and unnecessarily confining". Overall, the survey findings imply the existence of different measures used and different perceptions held (regarding profitability, risk, growth and regulation) by bank management in different countries. They also suggest that US markets offer the best opportunities at present for growth and development of banking services and for a loosening of regulatory constraints. Neither Canada nor Mexico appa- rently ranks as high in the perceived options for foreign banks attempting to penetrate the financial services field in those two countries.

SUMMARY AND ANALYSIS OF MULTINATIONAL BANKING TRENDS

Analysis of the operations of Canadian and Mexican banks operating in the US v is -a -v i s each other as well as with similar domestic US banks reveals significant variation in the the focus of their financial activities and in the commitment of financial resources. These differences were observed in bank loan-portfolio and source-of-funds composition, and in the nature of the clientele these banks service in US markets. The motivation to penetrate foreign markets results from various firm - and country-specific factors, such as comparative advantages, market imperfections, regulation, and service to domestic customers operating abroad. The findings reported here of two separate countries' banks exploiting different segments of a common market is consistent with any of these factors. No attempt was made in this study to relate observed differences to any specific factor. However, as all these factors comprise the theory of foreign direct investment (FDI), our results appear to be consistent with the evolving FDI theory of multinational banking. The findings of the international survey presented above are also consistent with


our analysis of Canadian and Mexican bank activity. They point out the need to incorporate the managerial factor as an explicit variable in the theory of multinational banking - akin to the evolving recognition of agency theory (Jensen and Meckling, 1976; Fama, 1980) in the context of single-currency financial theory's decision criteria - as different managerial perspectives can lead to differing strategies and, thus, differing decision criteria.

Despite numerous regulatory and cultural differences, the banking systems of Canada, Mexico and the United States reflect a number of common economic and financial pressures and bear the burden of changing government regulations, either toward greater free-market resource allocation and pricing decisions as in Canada and the US or toward greater central government involvement in the financial sector as in Mexico. These pressures are reflected in the responses to the international survey of bank service performance and managerial objectives among US, chartered Canadian, and Mexican banking institutions. For example, many responding banks viewed their foreign operations (particularly those con- ducted in the US) as more profitable than their domestic operations, the latter presently caught up in significant regulatory changes. Canadian banks, for example, unambiguously perceived their US operations to be more profitable than their domestic operations, whereas US banks in general viewed their Canadian operations as less profitable2 The surveyed banks' response to the issue of international risk measures, especially translation exposure, has major implications. This issue has been of critical concern to treasurers of multinational corporations (MNCs) since the advent of both floating exchange rates and the "emergency only" currency-market inter- vention policies of the US government. Briefly, all organizations with foreign operations consolidate those foreign operations for reporting purposes. As foreign accounting statements are maintained in the local currency of operation, conversion of these into US dollars (for US MNCs) has to occur at the then prevailing set of foreign-exchange rates. With recent wider variability in exchange rates, certainly beyond the control of management, substantial period-to-period variability in MNC accounting statements resulted. A variety of ingenious methods were utilized by MNCs to cope with this problem (Rodriguez, 1981).

To ensure uniformity in accounting statements of all US MNCs the Financial Accounting Standards Board (FASB) in 1975 issued Statement 8, titled "Account- ing for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements", mandating a specific translation procedure for all US mul- tinationals. The thrust of this was to identify specific asset, liability and income statement items from foreign operations which had to be converted into dollars at current exchange rates, and by resulting translation gains or losses to be incorporated in the parent's consolidated income statement. In recognition of the variability added to the parent's earnings and the often uneconomical strategies to hedge such "accounting" fluctuations undertaken by MNC treasurers (Rodriguez, 1981) 6, the FASB issued Statement 52. FAS 52 (1981) mandates MNCs from 1983 onwards to measure and report translation exposure gains or losses in a special equity account on the balance sheet rather than on the income statement, using the notion of "functional currency". Regulated changes such as these can have a significant influence on both MNC's profits reported to investors, in hedging methods employed as well as in investment and financing decisions. 7 Although exisiting studies on foreign-exchange exposure have been undertaken from the viewpoint of non-financial MNCs, results of the international banking survey suggest that the management of major banks in Canada, Mexico and the United States is as much concerned with this issue. Future research on the implications of regulatory changes regarding reporting of translation gains/losses and strategies for hedging foreign exchange exposure from the perspective of financial MNCs should be fruitful.


From a theoretical viewpoint, development of valuation models at the firm level and derivation of optimal decision criteria which assure optimal resource allocation within a society require knowledge of that social group's objective function, and the set of constraints facing the group. The latter includes quality and quantity of natural resources (such as land, labour, capital, etc.) and technological, cultural, political and regulatory constraints. Extant financial theory (Modigliani and Miller, 1958; Sharpe, 1964; Lintner, 1965; Black and Scholes, 1973; Ross, 1976; Modigliani and Miller, 1968) and derived decision criteria leading to value maximization for a domestic firm assume the existence of well-functioning markets - specifically, perfect financial markets. Meaningful theoretical solutions under imperfect financial markets can be obtained, but only to the extent these imperfections are systematic. 8 Derivation of proper decision criteria for MNCs whose operations extend into the boundaries of other social groups (countries) requires knowledge of these other countries' objectives and the nature of their markets. Were these the same in all countries, only then would the extant domestic financial theory and its decision criteria be valid for all multi-currency firms. Hence, both theoretical and practical considerations make it necessary to identify and evaluate the nature of differences which may exist in various markets - our focus being on only one segment of the financial market. These issues are also relevant for foreign-exchange rate determination and for "true" foreign-exchange risk assessment? The key differences observed here in the regulatory environment surrounding each nation's financial-service marketplace and in the histori- cal performance and decision criteria used by large multinational banks cast doubt on the efficacy of prescribing managerial decision criteria derived from single-currency frameworks and suggest a need for developing a distinctive resource allocation process in the context of a multi-currency environment.

ENDNOTES

1. For a substantially more detailed and complete analysis of differences in regulation and banking market structure in Mexico, Canada and the United States see especially Fieleke (1977), Dean and Giddy (1981), and Mahajan and Rose (1984).

2. Time series data for each group of banks were analyzed for each quarter to observe trends and variability; however these results are not reported here due to space considerations.

3. The overall borrowings of the Canadian banks in the federal funds market were stable, while Mexican bank participation in the funds market was erratic, suggesting an uncertain money- desk management policy among Mexican banking offices in the US.

4. Participating banks were asked to rank alternative bank profitability indicators - ROE, ROA, Return on Earning Assets, and Rate of Return Before Taxes and Securities Transactions - for both domestic and foreign operations. Responses suggested interesting differences in profitability measures used by Canadian compared to major US money-centre banks. While Canadian banks used return on assets (ROA) as their principal profitability criterion, US banks preferred return on earning assets (ROEA) for evaluating domestic service sales and ROA for their sales of banking services in other countries. Interestingly, return on equity (ROE), which would appear to be the most relevant earnings measure for the bank shareholders, was ranked relatively low by both groups of institutions.

5. These perceptions are validated by Rugman and Bennett (1982) who find multinational bank profitability (return on equity) in the US to be higher than in Canada. However, Lermer (1980) found Canadian chartered banks to maintain very high before-tax profit margins but only moderately higher after-tax profit margins than other industries due to the Canadian government's protective atlitude towards the Canadian banking industry.

6. A discussion of whether such fluctuations in earnings per share add real risk to an investor's portfolio is beyond the scope of this paper. Suffice it to say, these fluctuations will add no risk if the interest-rate parity theory and the purchasing-power parity theory are maintained.

7. For example, IBM's switch to FASB #52 resulted in a 10 per cent increase in its earnings (as reported in Financial Accounting Standards Board (1981)).

8. For example, Modigliani and Miller (1963) extended their original model to include tax deducta- bility of corporate interest payments.

9. Bilson (1979), Sotnik (1974; 1983), Grauer, Utzenberger and Stehte (1976), Stulz (1981), and Adler and Dumas (1983) examine the impact of the assumed nature of the markets on theoreti- cally derived exchange rates and on the notion of foreign exchange risk.


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