IMPACT OF FOREIGN BANKS ON PERFORMANCE OF DOMESTIC BANKS IN UK

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Impact Of Foreign Banks On Performance Of Domestic Banks In Uk



Methodology

This study uses information from the financial statements of domestic and foreign banks in the UK to form financial ratios and compare their performance as opposed to each other. The starting point for data collection was the “Institutions Included within the UK Banking Sector-nationality analysis” of the Bank of England which classifies the institutions in the following 6 categories: UK, US, EU, Other Developed, Other, Japanese. Fifty eight (26 domestic and 32 foreign) of the financial institutions included in the 31st March 2001 analysis, met the following two criteria and were included in the sample: 1. Classified as commercial in the Bankscope Database of Bureau van Dijk's company. This is a specialized database containing information on 11,000World Banks and is considered one of the most comprehensive databases widely used in banking research. The reason that only commercial banks were included in the sample was to avoid comparison problems between different types of banks such as savings, investment, cooperative, mortgage, etc. 2. Had complete annual data for all years between 1998 and 2001 in the Database.

Evaluation criteria

Financial ratios, despite some criticisms, are still used as a basis to evaluate a firm's performance, to make credit risk assessment decisions and classify firms 334 K. Kosmidou et al. into bankrupt and non-bankrupt groups. There is a great number of financial ratios which can be used for the evaluation of banks performance. For example, Golin (2001) provides a list of over 80 ratios covering the major categories of capital, asset quality, profitability & efficiency, and liquidity & funding.

This study focuses on profitability/efficiency ratios in order to get comparable results with most of the previous studies which employed estimates of cost and/or profit efficiency to determine efficiency differences between foreign and domestic banks. However, ratios measuring risk and liquidity are also employed in the analysis as a bank may increase profitability in the short term by taking excessive risks or decreasing its liquidity. For example, by lending to doubtful customers at high rates of interest the bank will increase profits in the short term but problems will probably emerge in the future when customers will stop paying back their loans. The ten ratios which were selected to measure the performance of domestic and foreign banks are presented below.

It is obvious that another set of financial ratios could have probably been selected. However, an effortwas made, to select well known ratios, used in previous research in banking, which at one hand would be representative of the previously mentioned major categories (profitability, efficiency etc.); while at the other hand would remain in a manageable number for the model's formulation.

• Return on equity (ROE), is the net profit after tax divided by the shareholder's equity and is of particular interest to equity investors as it measures the return on their investment.

• Return on assets (ROA), is the net profit after tax divided ...