Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What do we do? Take a model comparable to Bernard et al. (2003) and De Blas and Russ (2012) Models of comparative cost advantage Our basic assumptions Banks have different levels of productivity.. ... and therefore different marginal costs operating abroad Cost difference used to overcome fixed costs of exporting Next steps: Define a profit function of banks’ affiliate lending. Banks are present abroad if profit ( π ) > 0 Derive an empirical specification (probit) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What do we do? Take a model comparable to Bernard et al. (2003) and De Blas and Russ (2012) Models of comparative cost advantage Our basic assumptions Banks have different levels of productivity.. ... and therefore different marginal costs operating abroad Cost difference used to overcome fixed costs of exporting Next steps: Define a profit function of banks’ affiliate lending. Banks are present abroad if profit ( π ) > 0 Derive an empirical specification (probit) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What do we do? Take a model comparable to Bernard et al. (2003) and De Blas and Russ (2012) Models of comparative cost advantage Our basic assumptions Banks have different levels of productivity.. ... and therefore different marginal costs operating abroad Cost difference used to overcome fixed costs of exporting Next steps: Define a profit function of banks’ affiliate lending. Banks are present abroad if profit ( π ) > 0 Derive an empirical specification (probit) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What do we do? Take a model comparable to Bernard et al. (2003) and De Blas and Russ (2012) Models of comparative cost advantage Our basic assumptions Banks have different levels of productivity.. ... and therefore different marginal costs operating abroad Cost difference used to overcome fixed costs of exporting Next steps: Define a profit function of banks’ affiliate lending. Banks are present abroad if profit ( π ) > 0 Derive an empirical specification (probit) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What do we do? Take a model comparable to Bernard et al. (2003) and De Blas and Russ (2012) Models of comparative cost advantage Our basic assumptions Banks have different levels of productivity.. ... and therefore different marginal costs operating abroad Cost difference used to overcome fixed costs of exporting Next steps: Define a profit function of banks’ affiliate lending. Banks are present abroad if profit ( π ) > 0 Derive an empirical specification (probit) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What do we do? Take a model comparable to Bernard et al. (2003) and De Blas and Russ (2012) Models of comparative cost advantage Our basic assumptions Banks have different levels of productivity.. ... and therefore different marginal costs operating abroad Cost difference used to overcome fixed costs of exporting Next steps: Define a profit function of banks’ affiliate lending. Banks are present abroad if profit ( π ) > 0 Derive an empirical specification (probit) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What do we do? Take a model comparable to Bernard et al. (2003) and De Blas and Russ (2012) Models of comparative cost advantage Our basic assumptions Banks have different levels of productivity.. ... and therefore different marginal costs operating abroad Cost difference used to overcome fixed costs of exporting Next steps: Define a profit function of banks’ affiliate lending. Banks are present abroad if profit ( π ) > 0 Derive an empirical specification (probit) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data When do banks conduct foreign affiliate lending? When π > 0! Consider profit bank i of lending to country j π ij = R L ij L ij − ( R D i + η j )( 1 /γ ) D i − R D ij ( 1 /ψ ) D ij − F j Foreign lending financed by affiliate and parent deposits ( 1 /γ ) D i = α ij L ij ( 1 /ψ ) D ij = ( 1 − α ij ) L ij Substituting.. π ij = R L ij L ij − ( R D i + η j ) α ij L ij − R D ij ( 1 − α ij ) L ij − F j (1) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data When do banks conduct foreign affiliate lending? When π > 0! Consider profit bank i of lending to country j π ij = R L ij L ij − ( R D i + η j )( 1 /γ ) D i − R D ij ( 1 /ψ ) D ij − F j Foreign lending financed by affiliate and parent deposits ( 1 /γ ) D i = α ij L ij ( 1 /ψ ) D ij = ( 1 − α ij ) L ij Substituting.. π ij = R L ij L ij − ( R D i + η j ) α ij L ij − R D ij ( 1 − α ij ) L ij − F j (1) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data When do banks conduct foreign affiliate lending? When π > 0! Consider profit bank i of lending to country j π ij = R L ij L ij − ( R D i + η j )( 1 /γ ) D i − R D ij ( 1 /ψ ) D ij − F j Foreign lending financed by affiliate and parent deposits ( 1 /γ ) D i = α ij L ij ( 1 /ψ ) D ij = ( 1 − α ij ) L ij Substituting.. π ij = R L ij L ij − ( R D i + η j ) α ij L ij − R D ij ( 1 − α ij ) L ij − F j (1) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What are the sources of profit? The price and the cost markup. Rewriting Equation (1) π ij = L ij ( R L ij − R D + α ij L ij ( R D ij − ( R D ij ) i + η j )) − F j � �� � � �� � Price markup Funding cost markup Price and cost margin Price markup : Intermediation margin (net interest margin) earned in the (imperfectly competitive) foreign market. Funding cost markup : Intermediation margin earned on fraction α ij of lending financed with parent deposits. Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What are the sources of profit? The price and the cost markup. Rewriting Equation (1) π ij = L ij ( R L ij − R D + α ij L ij ( R D ij − ( R D ij ) i + η j )) − F j � �� � � �� � Price markup Funding cost markup Price and cost margin Price markup : Intermediation margin (net interest margin) earned in the (imperfectly competitive) foreign market. Funding cost markup : Intermediation margin earned on fraction α ij of lending financed with parent deposits. Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What are the sources of profit? The price and the cost markup. Rewriting Equation (1) π ij = L ij ( R L ij − R D + α ij L ij ( R D ij − ( R D ij ) i + η j )) − F j � �� � � �� � Price markup Funding cost markup Price and cost margin Price markup : Intermediation margin (net interest margin) earned in the (imperfectly competitive) foreign market. Funding cost markup : Intermediation margin earned on fraction α ij of lending financed with parent deposits. Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data What are the sources of profit? The price and the cost markup. Rewriting Equation (1) π ij = L ij ( R L ij − R D + α ij L ij ( R D ij − ( R D ij ) i + η j )) − F j � �� � � �� � Price markup Funding cost markup Price and cost margin Price markup : Intermediation margin (net interest margin) earned in the (imperfectly competitive) foreign market. Funding cost markup : Intermediation margin earned on fraction α ij of lending financed with parent deposits. Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Why would parent banks have a funding cost advantage? Main hypothesis: parent banks have a funding cost advantage vis-à-vis foreign incumbants, e.g. due to: Scale economies in global wholesale funding. Cost advantages from managing liquidity on a global scale (Cetorelli and Golberg, JF and JIE 2012). Accordingly, we define: C 2 j / C ij ≡ R D ij − ( R D i − η j ) Substituting we arrive at: π ij = L ij ( R L ij − R D ij ) + α ij L ij ( C 2 j / C ij ) − F j � �� � � �� � Cost markup Price markup Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Why would parent banks have a funding cost advantage? Main hypothesis: parent banks have a funding cost advantage vis-à-vis foreign incumbants, e.g. due to: Scale economies in global wholesale funding. Cost advantages from managing liquidity on a global scale (Cetorelli and Golberg, JF and JIE 2012). Accordingly, we define: C 2 j / C ij ≡ R D ij − ( R D i − η j ) Substituting we arrive at: π ij = L ij ( R L ij − R D ij ) + α ij L ij ( C 2 j / C ij ) − F j � �� � � �� � Cost markup Price markup Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Why would parent banks have a funding cost advantage? Main hypothesis: parent banks have a funding cost advantage vis-à-vis foreign incumbants, e.g. due to: Scale economies in global wholesale funding. Cost advantages from managing liquidity on a global scale (Cetorelli and Golberg, JF and JIE 2012). Accordingly, we define: C 2 j / C ij ≡ R D ij − ( R D i − η j ) Substituting we arrive at: π ij = L ij ( R L ij − R D ij ) + α ij L ij ( C 2 j / C ij ) − F j � �� � � �� � Cost markup Price markup Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Why would parent banks have a funding cost advantage? Main hypothesis: parent banks have a funding cost advantage vis-à-vis foreign incumbants, e.g. due to: Scale economies in global wholesale funding. Cost advantages from managing liquidity on a global scale (Cetorelli and Golberg, JF and JIE 2012). Accordingly, we define: C 2 j / C ij ≡ R D ij − ( R D i − η j ) Substituting we arrive at: π ij = L ij ( R L ij − R D ij ) + α ij L ij ( C 2 j / C ij ) − F j � �� � � �� � Cost markup Price markup Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Why would parent banks have a funding cost advantage? Main hypothesis: parent banks have a funding cost advantage vis-à-vis foreign incumbants, e.g. due to: Scale economies in global wholesale funding. Cost advantages from managing liquidity on a global scale (Cetorelli and Golberg, JF and JIE 2012). Accordingly, we define: C 2 j / C ij ≡ R D ij − ( R D i − η j ) Substituting we arrive at: π ij = L ij ( R L ij − R D ij ) + α ij L ij ( C 2 j / C ij ) − F j � �� � � �� � Cost markup Price markup Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Towards an empirical specification Country lending income equals aggregate capital income � � MPK j × K j j × L j → L ij ≡ β ij L D MPK j × K j ≡ R ∗ j ≡ R ∗ j To derive a log-linear specification, we also define: M P ij ≡ µ ij ( C 2 j / C ij ) NIM j ≡ µ ij /α ij Banks are likely to be present when π ij > 0: π ij = ( 1 + NIM j )( C 2 j / C ij ) α ij β ij MPK j K j ( 1 / R ∗ j ) − F j > 0 (2) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Towards an empirical specification Country lending income equals aggregate capital income � � MPK j × K j j × L j → L ij ≡ β ij L D MPK j × K j ≡ R ∗ j ≡ R ∗ j To derive a log-linear specification, we also define: M P ij ≡ µ ij ( C 2 j / C ij ) NIM j ≡ µ ij /α ij Banks are likely to be present when π ij > 0: π ij = ( 1 + NIM j )( C 2 j / C ij ) α ij β ij MPK j K j ( 1 / R ∗ j ) − F j > 0 (2) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Towards an empirical specification Country lending income equals aggregate capital income � � MPK j × K j j × L j → L ij ≡ β ij L D MPK j × K j ≡ R ∗ j ≡ R ∗ j To derive a log-linear specification, we also define: M P ij ≡ µ ij ( C 2 j / C ij ) NIM j ≡ µ ij /α ij Banks are likely to be present when π ij > 0: π ij = ( 1 + NIM j )( C 2 j / C ij ) α ij β ij MPK j K j ( 1 / R ∗ j ) − F j > 0 (2) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Towards an empirical specification Country lending income equals aggregate capital income � � MPK j × K j j × L j → L ij ≡ β ij L D MPK j × K j ≡ R ∗ j ≡ R ∗ j To derive a log-linear specification, we also define: M P ij ≡ µ ij ( C 2 j / C ij ) NIM j ≡ µ ij /α ij Banks are likely to be present when π ij > 0: π ij = ( 1 + NIM j )( C 2 j / C ij ) α ij β ij MPK j K j ( 1 / R ∗ j ) − F j > 0 (2) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Towards an empirical specification Country lending income equals aggregate capital income � � MPK j × K j j × L j → L ij ≡ β ij L D MPK j × K j ≡ R ∗ j ≡ R ∗ j To derive a log-linear specification, we also define: M P ij ≡ µ ij ( C 2 j / C ij ) NIM j ≡ µ ij /α ij Banks are likely to be present when π ij > 0: π ij = ( 1 + NIM j )( C 2 j / C ij ) α ij β ij MPK j K j ( 1 / R ∗ j ) − F j > 0 (2) Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Deriving the probability of having foreign lending Define Z > 1 if bank i is in country j Z ij = ( 1 + NIM j )( C 2 j / C ij ) α ij β ij MPK j K j > 1 F j R ∗ j Probit is derived by taking the natural logarithm: z ijt = γ 0 + γ 0 nim jt + γ 2 c 2 jt − γ 3 c it − γ 4 α jt + γ 5 β ijt + γ 6 r ∗ jt + γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t + ε ijt Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Deriving the probability of having foreign lending Define Z > 1 if bank i is in country j Z ij = ( 1 + NIM j )( C 2 j / C ij ) α ij β ij MPK j K j > 1 F j R ∗ j Probit is derived by taking the natural logarithm: z ijt = γ 0 + γ 0 nim jt + γ 2 c 2 jt − γ 3 c it − γ 4 α jt + γ 5 β ijt + γ 6 r ∗ jt + γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t + ε ijt Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Which signs do we expect? Probit: ρ ijt = Pr ( T ijt = 1 | Observables ) ρ ijt = Φ( γ 0 + γ 1 nim jt + γ 2 c 2 jt − γ 3 c ijt − γ 4 α ijt + γ 5 β ijt + γ 6 r jt − γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t ) Probability of presence... ...positively related to the intermediation margin nim jt ...positively related to MC foreign cost leaders c 2 jt ...negatively related to MC German bank c ijt ...positively related to comparative MCs: I ( c 2 jt > c it ) ...negatively related to foreign loan rates r jt (quantity effect) ...negatively related to fixed operating costs f j Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Which signs do we expect? Probit: ρ ijt = Pr ( T ijt = 1 | Observables ) ρ ijt = Φ( γ 0 + γ 1 nim jt + γ 2 c 2 jt − γ 3 c ijt − γ 4 α ijt + γ 5 β ijt + γ 6 r jt − γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t ) Probability of presence... ...positively related to the intermediation margin nim jt ...positively related to MC foreign cost leaders c 2 jt ...negatively related to MC German bank c ijt ...positively related to comparative MCs: I ( c 2 jt > c it ) ...negatively related to foreign loan rates r jt (quantity effect) ...negatively related to fixed operating costs f j Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Which signs do we expect? Probit: ρ ijt = Pr ( T ijt = 1 | Observables ) ρ ijt = Φ( γ 0 + γ 1 nim jt + γ 2 c 2 jt − γ 3 c ijt − γ 4 α ijt + γ 5 β ijt + γ 6 r jt − γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t ) Probability of presence... ...positively related to the intermediation margin nim jt ...positively related to MC foreign cost leaders c 2 jt ...negatively related to MC German bank c ijt ...positively related to comparative MCs: I ( c 2 jt > c it ) ...negatively related to foreign loan rates r jt (quantity effect) ...negatively related to fixed operating costs f j Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Which signs do we expect? Probit: ρ ijt = Pr ( T ijt = 1 | Observables ) ρ ijt = Φ( γ 0 + γ 1 nim jt + γ 2 c 2 jt − γ 3 c ijt − γ 4 α ijt + γ 5 β ijt + γ 6 r jt − γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t ) Probability of presence... ...positively related to the intermediation margin nim jt ...positively related to MC foreign cost leaders c 2 jt ...negatively related to MC German bank c ijt ...positively related to comparative MCs: I ( c 2 jt > c it ) ...negatively related to foreign loan rates r jt (quantity effect) ...negatively related to fixed operating costs f j Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Which signs do we expect? Probit: ρ ijt = Pr ( T ijt = 1 | Observables ) ρ ijt = Φ( γ 0 + γ 1 nim jt + γ 2 c 2 jt − γ 3 c ijt − γ 4 α ijt + γ 5 β ijt + γ 6 r jt − γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t ) Probability of presence... ...positively related to the intermediation margin nim jt ...positively related to MC foreign cost leaders c 2 jt ...negatively related to MC German bank c ijt ...positively related to comparative MCs: I ( c 2 jt > c it ) ...negatively related to foreign loan rates r jt (quantity effect) ...negatively related to fixed operating costs f j Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Which signs do we expect? Probit: ρ ijt = Pr ( T ijt = 1 | Observables ) ρ ijt = Φ( γ 0 + γ 1 nim jt + γ 2 c 2 jt − γ 3 c ijt − γ 4 α ijt + γ 5 β ijt + γ 6 r jt − γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t ) Probability of presence... ...positively related to the intermediation margin nim jt ...positively related to MC foreign cost leaders c 2 jt ...negatively related to MC German bank c ijt ...positively related to comparative MCs: I ( c 2 jt > c it ) ...negatively related to foreign loan rates r jt (quantity effect) ...negatively related to fixed operating costs f j Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Which signs do we expect? Probit: ρ ijt = Pr ( T ijt = 1 | Observables ) ρ ijt = Φ( γ 0 + γ 1 nim jt + γ 2 c 2 jt − γ 3 c ijt − γ 4 α ijt + γ 5 β ijt + γ 6 r jt − γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t ) Probability of presence... ...positively related to the intermediation margin nim jt ...positively related to MC foreign cost leaders c 2 jt ...negatively related to MC German bank c ijt ...positively related to comparative MCs: I ( c 2 jt > c it ) ...negatively related to foreign loan rates r jt (quantity effect) ...negatively related to fixed operating costs f j Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Which signs do we expect? Probit: ρ ijt = Pr ( T ijt = 1 | Observables ) ρ ijt = Φ( γ 0 + γ 1 nim jt + γ 2 c 2 jt − γ 3 c ijt − γ 4 α ijt + γ 5 β ijt + γ 6 r jt − γ 7 mpk jt + γ 8 k jt − γ 9 f j − γ 10 φ t ) Probability of presence... ...positively related to the intermediation margin nim jt ...positively related to MC foreign cost leaders c 2 jt ...negatively related to MC German bank c ijt ...positively related to comparative MCs: I ( c 2 jt > c it ) ...negatively related to foreign loan rates r jt (quantity effect) ...negatively related to fixed operating costs f j Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data How do we estimate marginal costs and prices? Key starting premise German affiliates’ cost advantage in country j is due to the parent’s cost advantage. Estimation steps Sample of world banks from Bankscope Estimate cost and profit frontiers for all world banks Calculate marginal costs Use marginal costs German banks as c it c 2 jt : 5th percentile of marginal costs in each country r jt : 5th percentile of average revenues in each country Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data How do we estimate marginal costs and prices? Key starting premise German affiliates’ cost advantage in country j is due to the parent’s cost advantage. Estimation steps Sample of world banks from Bankscope Estimate cost and profit frontiers for all world banks Calculate marginal costs Use marginal costs German banks as c it c 2 jt : 5th percentile of marginal costs in each country r jt : 5th percentile of average revenues in each country Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data How do we estimate marginal costs and prices? Key starting premise German affiliates’ cost advantage in country j is due to the parent’s cost advantage. Estimation steps Sample of world banks from Bankscope Estimate cost and profit frontiers for all world banks Calculate marginal costs Use marginal costs German banks as c it c 2 jt : 5th percentile of marginal costs in each country r jt : 5th percentile of average revenues in each country Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data How do we estimate marginal costs and prices? Key starting premise German affiliates’ cost advantage in country j is due to the parent’s cost advantage. Estimation steps Sample of world banks from Bankscope Estimate cost and profit frontiers for all world banks Calculate marginal costs Use marginal costs German banks as c it c 2 jt : 5th percentile of marginal costs in each country r jt : 5th percentile of average revenues in each country Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data How do we estimate marginal costs and prices? Key starting premise German affiliates’ cost advantage in country j is due to the parent’s cost advantage. Estimation steps Sample of world banks from Bankscope Estimate cost and profit frontiers for all world banks Calculate marginal costs Use marginal costs German banks as c it c 2 jt : 5th percentile of marginal costs in each country r jt : 5th percentile of average revenues in each country Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data How do we estimate marginal costs and prices? Key starting premise German affiliates’ cost advantage in country j is due to the parent’s cost advantage. Estimation steps Sample of world banks from Bankscope Estimate cost and profit frontiers for all world banks Calculate marginal costs Use marginal costs German banks as c it c 2 jt : 5th percentile of marginal costs in each country r jt : 5th percentile of average revenues in each country Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data How do we estimate marginal costs and prices? Key starting premise German affiliates’ cost advantage in country j is due to the parent’s cost advantage. Estimation steps Sample of world banks from Bankscope Estimate cost and profit frontiers for all world banks Calculate marginal costs Use marginal costs German banks as c it c 2 jt : 5th percentile of marginal costs in each country r jt : 5th percentile of average revenues in each country Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data How do we estimate marginal costs and prices? Key starting premise German affiliates’ cost advantage in country j is due to the parent’s cost advantage. Estimation steps Sample of world banks from Bankscope Estimate cost and profit frontiers for all world banks Calculate marginal costs Use marginal costs German banks as c it c 2 jt : 5th percentile of marginal costs in each country r jt : 5th percentile of average revenues in each country Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Bank data Bankscope data 2003-2010 Commercial, savings, cooperative and investment banks Drop entries with negative factor prices, outputs, costs, equity and total assets Winsorize factor prices and outputs at 1% Deflate all monetary volumes using CPI Cost and profit function estimates for 108,704 observations Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Bank data Bankscope data 2003-2010 Commercial, savings, cooperative and investment banks Drop entries with negative factor prices, outputs, costs, equity and total assets Winsorize factor prices and outputs at 1% Deflate all monetary volumes using CPI Cost and profit function estimates for 108,704 observations Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Bank data Bankscope data 2003-2010 Commercial, savings, cooperative and investment banks Drop entries with negative factor prices, outputs, costs, equity and total assets Winsorize factor prices and outputs at 1% Deflate all monetary volumes using CPI Cost and profit function estimates for 108,704 observations Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Bank data Bankscope data 2003-2010 Commercial, savings, cooperative and investment banks Drop entries with negative factor prices, outputs, costs, equity and total assets Winsorize factor prices and outputs at 1% Deflate all monetary volumes using CPI Cost and profit function estimates for 108,704 observations Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Bank data Bankscope data 2003-2010 Commercial, savings, cooperative and investment banks Drop entries with negative factor prices, outputs, costs, equity and total assets Winsorize factor prices and outputs at 1% Deflate all monetary volumes using CPI Cost and profit function estimates for 108,704 observations Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Bank data Bankscope data 2003-2010 Commercial, savings, cooperative and investment banks Drop entries with negative factor prices, outputs, costs, equity and total assets Winsorize factor prices and outputs at 1% Deflate all monetary volumes using CPI Cost and profit function estimates for 108,704 observations Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Foreign status data External Position Report ( Auslandsstatus data ) from the Bundesbank End-of-year data loans and advances of German banks to foreign affiliates Exclude interbank lending; only enterprises, households and governments Data from 2003-2010 After merge with Bankscope data: 1590 German banks in 52 countries Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Foreign status data External Position Report ( Auslandsstatus data ) from the Bundesbank End-of-year data loans and advances of German banks to foreign affiliates Exclude interbank lending; only enterprises, households and governments Data from 2003-2010 After merge with Bankscope data: 1590 German banks in 52 countries Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Foreign status data External Position Report ( Auslandsstatus data ) from the Bundesbank End-of-year data loans and advances of German banks to foreign affiliates Exclude interbank lending; only enterprises, households and governments Data from 2003-2010 After merge with Bankscope data: 1590 German banks in 52 countries Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Foreign status data External Position Report ( Auslandsstatus data ) from the Bundesbank End-of-year data loans and advances of German banks to foreign affiliates Exclude interbank lending; only enterprises, households and governments Data from 2003-2010 After merge with Bankscope data: 1590 German banks in 52 countries Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Foreign status data External Position Report ( Auslandsstatus data ) from the Bundesbank End-of-year data loans and advances of German banks to foreign affiliates Exclude interbank lending; only enterprises, households and governments Data from 2003-2010 After merge with Bankscope data: 1590 German banks in 52 countries Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Macroeconomic data and other controls Macro data mpk jt & k jt : PWT 8.0 data, Feenstra et al. (2013) German FDI: MiDI database Bundesbank Distance: CPII Capital regulation & Activity restrictions: Barth & Levine (2001) Other bank controls Return on equity Loan impairment charges Cost-to-income ratio Z-score Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Commercial banks most important Commercials Savings Coops Total # banks 104 468 1018 1590 # banks abroad 24 13 6 43 # countries ≥ 1 affiliate 52 51 49 52 In million euros... Av. lending per bank 57.80 16.90 3.65 39.10 Av. lending per country 17,60 16.50 17.70 17.20 Galema, Liesegang, Koetter Cost leadership
Theory Literature and contribution Probit Theory and empirics Marginal costs and prices Results Data Summary of ijt sample Not Abroad Abroad N = 394,780 N =3,610 mean std mean std Bank marginal costs ( c it ) 0 . 038 0 . 008 0 . 029 0 . 015 Marginal costs abroad ( c 2 jt ) 0 . 025 0 . 021 0 . 024 0 . 019 Cost leadership ( I ( c 2 jt > c it )) 0 . 179 0 . 384 0 . 366 0 . 482 Price of capital ( r jt ) 4 . 433 3 . 341 4 . 244 3 . 181 Return on equity ( roe ) 17 . 290 7 . 566 14 . 154 14 . 959 Z-score ( zs ) 33 . 323 19 . 136 16 . 014 11 . 245 Credit risk ( cr ) 0 . 893 0 . 745 0 . 635 0 . 950 Cost-to-income ratio ( cit ) 40 . 189 8 . 996 24 . 784 14 . 910 Loans and advances abroad 0 . 000 0 . 000 987 . 918 7800 . 031 Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results Comparative cost advantage matters (1) Marginal effects, ’03-’10 Controls: None Individual Joint − 0 . 0258 ∗∗∗ − 0 . 0139 ∗∗∗ − 0 . 0094 ∗∗∗ − 0 . 0037 ∗∗∗ c it − 0 . 0034 ∗∗∗ − 0 . 0023 ∗ c 2 jt − 0 . 0023 ∗ − 0 . 0012 I ( c 2 jt > c it ) 0 . 0047 ∗∗∗ 0 . 0027 ∗∗∗ 0 . 0028 ∗∗∗ 0 . 0016 ∗∗∗ nim jt 0 . 0044 0 . 0030 0 . 0030 0 . 0038 r jt 0 . 0022 0 . 0017 0 . 0016 0 . 0009 k − 0 . 0010 − 0 . 0002 0 . 0001 0 . 0003 mpk 0 . 0017 0 . 0015 0 . 0015 0 . 0011 α jt 0 . 0012 ∗∗ 0 . 0008 0 . 0007 0 . 0005 β jt 0 . 0029 0 . 0026 0 . 0029 0 . 0024 Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results Comparative cost advantage matters (2) I Marginal effects, ’03-’10 Controls: None Individual Joint roe − 0 . 0168 ∗∗∗ − 0 . 0275 ∗∗∗ z - score − 0 . 0052 ∗∗∗ − 0 . 0006 ∗∗ credit risk cost - income ratio − 0 . 0198 ∗∗∗ − 0 . 0213 ∗∗∗ f j Yes Yes Yes Yes φ t Yes Yes Yes Yes bank group dummies No Yes Yes Yes N 398 , 390 398 , 390 398 , 390 397 , 547 R 2 0 . 3254 0 . 3267 0 . 4289 0 . 4643 Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results How to interpret the size of the effects? Aren’t they very small? No, because number of banks abroad is very small. The 5th percentile of fitted values is almost 0% The 95th percentile of fitted values is typically around 2% Some quantitative effects: c it ↓ 1% → Probability abroad ↑ 0.37%. c 2 jt > c it → Probability abroad ↑ 0.16%. These effects are economically significant compared to: German FDI ↑ 1% Probability abroad ↑ 0.16%. An uncondictional likelihood of foreign presence of 0.9%. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results Fixed costs have their predicted signs (1) Marginal effects ’03-’10 Fixed costs Branches Subsidiaries c it − 0 . 0037 ∗∗∗ 0 . 0002 − 0 . 0026 ∗∗∗ c 2 jt 0 . 0011 − 0 . 0001 − 0 . 0014 I ( c 2 jt > c it ) 0 . 0008 0 . 0005 0 . 0009 ∗ nim jt − 0 . 0002 0 . 0028 0 . 0003 r jt − 0 . 0013 − 0 . 0001 0 . 0012 k 0 . 0007 − 0 . 0006 0 . 0000 mpk − 0 . 0014 − 0 . 0002 0 . 0016 α jt 0 . 0003 0 . 0004 0 . 0002 β jt − 0 . 0035 ∗∗∗ 0 . 0031 0 . 0013 Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results Fixed costs have their predicted signs (2) Marginal effects ’03-’10 Fixed costs Branches Subsidiaries German FDI 0 . 0016 ∗∗∗ Distance 0 . 0001 Capital restrictions − 0 . 0004 − 0 . 0030 ∗∗ Activity restrictions Bank controls Yes Yes Yes f j No Yes Yes φ j Yes Yes Yes bank group dummies Yes Yes Yes N 370 , 607 397 , 547 397 , 547 R 2 0 . 5421 0 . 4373 0 . 5746 Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results Additional results Country groups: Cost leadership only significant for less-developed and non-Euro and non-OECD countries. Cost leadership signficantly negative for financial centers. Volume of affiliate lending: Amount lent depends mostly on country characteristics, like the net interest margin. It does not depend on bank characteristics like cost advantage, marginal cost or risk considerations. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results Additional results Country groups: Cost leadership only significant for less-developed and non-Euro and non-OECD countries. Cost leadership signficantly negative for financial centers. Volume of affiliate lending: Amount lent depends mostly on country characteristics, like the net interest margin. It does not depend on bank characteristics like cost advantage, marginal cost or risk considerations. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results Additional results Country groups: Cost leadership only significant for less-developed and non-Euro and non-OECD countries. Cost leadership signficantly negative for financial centers. Volume of affiliate lending: Amount lent depends mostly on country characteristics, like the net interest margin. It does not depend on bank characteristics like cost advantage, marginal cost or risk considerations. Galema, Liesegang, Koetter Cost leadership
Literature and contribution Main results Probit Theory and empirics Main results Probit without country-fixed effects Results Additional results Additional results Country groups: Cost leadership only significant for less-developed and non-Euro and non-OECD countries. Cost leadership signficantly negative for financial centers. Volume of affiliate lending: Amount lent depends mostly on country characteristics, like the net interest margin. It does not depend on bank characteristics like cost advantage, marginal cost or risk considerations. Galema, Liesegang, Koetter Cost leadership
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