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

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