Canadian international banking :empirical tests of the profit maximization and portfolio diversification hypotheses
Date
1987
Authors
Xu, Jixin
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Abstract
Two different theories have been advanced to explain international banking activities; these are the Profit Maximization Hypothesis and the Portfolio Diversification Hypothesis. This thesis has examined the extent to which both hypotheses can explain Canadian chartered banks' international operations.
In the supply oriented profit maximization approach, the Market Structure-Performance and Customer Relationship Hypotheses are presented and empirically tested. The Market Structure-Performance Hypothesis seeks to explain the profitability of Canadian banks' international operations in terms of their degree of participation in different market areas, whereas the Customer Relationship Hypothesis explains the international operations of Canadian banks in terms of serving the international activities of their clients.
In the demand oriented portfolio diversification approach, risk reduction is the central motive underlying Canadian banks' international operations. This hypothesis is evaluated through tests on the rates of return on banks' domestic and international asset portfolios. Conditions for portfolio diversification in order to reduce risk are examined.
Empirical results show that there is little confirmation of the relationship that is expected to exist between Canadian banks' international profitability and conditions of competitive imperfection in the markets where they operate. A proportional relationship is found between Canadian banks' international operations and the flows of trade between Canada and the rest of the world; however, no evidence is found to support a relationship between banks' overseas activities and non-bank firms' direct foreign investments.
The conditions for portfolio diversification are developed and empirically evaluated. It is shown that portfolio diversification, which increases the stability of banks' earnings, is an important motivation for Canadian banks' international operations.
The major finding of the study is that both the Profit Maximization Hypothesis and the Portfolio Diversification Hypothesis are complementary as motives for Canadian international banking.
Insofar as the thesis has determined that Canadian banks' international operations vary with Canada's external trade, and reflect the banks' strategies of portfolio diversification and risk reduction, growing trade protectionism within major industrialized countries and a worsening international debt crisis imply that the significance of Canadian international banking operations may be expected to decline in the future.