Cultural distance and cross-border bank linkages

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Highlights

  • This paper examines the effect of cultural distance on global bank linkages using country-pair data for the period 1990–2013.

  • Empirical results show that cultural distance has a negative association with bank linkages.

  • This effect is robust when controlling for various dimensions of distance.

  • The effect also becomes stronger in countries featuring higher informational asymmetries.

  • Our results also hold true for alternative measures of bank connections and cultural distance

Abstract

This study investigates the effect of cultural distance on global bank linkages using country-pair data for the period 1990–2013. We followed Schwartz (2006) to measure cultural distance, and employed the number of bank pairs involved in cross-border syndicated lending from the source to target countries as a measure of bank linkages. We found that cultural distance has a negative association with bank linkages. This effect is stronger in countries featuring higher informational asymmetries, as represented by weaker institutions, higher uncertainty, or revolution shocks. Our results hold even when employing alternative measures of bank linkages and cultural distance, and when considering the potential endogeneity of cultural distance.

Introduction

In the current era of globalization, the internalization of the banking industry has made remarkable progress in the past two decades, especially in developing countries, where the pace of internationalization has been rapid. Cultural similarities are considered an essential factor in this internationalization, as they mitigate informational asymmetries to enable economic exchanges (Portes and Rey, 2005; Guiso et al., 2009) and promote the trend of making banking investments abroad. As argued by Portes and Rey (2005), similarities in culture can minimize the costs of evaluating and monitoring cross-border borrowers and investment plans. Further, making banking investments in foreign countries may entail a distinct institutional constraint (Siegel et al., 2011). The degree of institutional compatibility between the source and target countries can be explained in terms of cultural distance. The greater the cultural distance, the more difficult it is to price assets, and the less acceptable differences in corporate governance practices become. In these circumstances, stakeholder/manager relationships are more difficult to manage and negotiations are more likely to fail. Undoubtedly, there is a causal link between cultural distance and global investments, especially in the banking industry; however, there is also the broader issue of potential investment in countries with weak financial institutions or high economic uncertainty. The issue of institutional setting and uncertainty may be relevant, because foreign investors are more likely to choose unsuitable partners and make poor investments in countries with weak institutions and high uncertainty (Poelhekke, 2015). Addressing this issue is important, since it potentially elaborates the relationship between cross-border banking flows and cultural distance.

In this study, we employ a gravity model for country-pair data, to explore the effects of cultural distance on global bank linkages. The cultural measure suggested by Schwartz (2006) is used. In particular, the cultural theory proposed by Schwartz (2006) involves three key societal issues and corresponding dimensions for cross-cultural analysis. By analyzing differences in how universally recognized values are prioritized by the national population, the model developed by Schwartz (2006) operationalizes the cultural profiles of countries, with the derived profiles being superior to other cultural value dimensions (Siegel et al., 2011). The reasons are as follows. First, the central elements of Schwartz’s model are derived from previous studies in the social sciences. Second, Schwartz (2006) operationalizes the cultural dimensions by employing value measures that capture cross-culturally equivalent meanings at the individual level. Hofstede (2001) also identifies key cultural value dimensions1 . However, Nadler and Breuer (2019) show that the cultural dimensions of Schwartz are more suitable than those of Hofstede in assessing the effect of social preferences on financial decision-making, because—unlike Schwartz’s dimensions—Hofstede’s dimensions do not capture the underlying individual cultural values. Moreover, Schwartz’s dimensions consider cultural impacts by including social preferences, which are new characteristics for decision-makers in cultural finance. When the Schwartz dimensions are applied, decision makers can integrate ecological and social targets into traditional economic targets that are consistent with a much broader concept of culture. Moreover, Schwartz’s dimensions also capture indirect cultural impacts. Conversely, Hofstede’s dimensions are applied as proxies for either the uncertainty or time preferences of decision-makers, which seem to be especially suitable for traditional finance. Using Hofstede’s dimensions to measure the impact of cultural distance on bank linkages—a type of financial decision-making—therefore seems inappropriate.

We follow Caballero et al. (2018) and use the number of bank pairs involved in cross-border syndicated lending from the source to target countries, as a measure of the bank linkages of each country. Unlike cross-border flows of stocks and outstanding bank claims based on the Bank for International Settlements database and bank-ownership linkages (Claessens and Horen, 2014), our measure captures banks’ information acquisition, as it is based on the long-term interbank relationship. We augment the model by adding institutional risk factors to capture a higher level of information asymmetry, and these are then interacted with our measure of bank linkages. With this approach, we make two main contributions to the bank linkage literature. First, this paper documents a negative nexus between cultural distance and international bank linkages. Second, it refines our understanding of the role of culture in driving cross-border bilateral capital flows for a source country with weaker institutions, higher uncertainty, or revolution shocks.

We analyze international banking investment flows by using global country-pair data from 1990 to 2013. The empirical results indicate a strong negative effect of cultural distance on cross-border capital flows. We also conduct a robustness check by controlling for various dimensions of distance, including geographical distance and the distance between the levels of financial market development in two countries. Further, we find that the effect of cultural distance on cross-border capital flows is stronger in countries that either have weak institutions or face high uncertainty and shocks, leading to greater information asymmetry and risky investments. Specifically, we find this is more evident in countries dominated by a single religious group, those where the legal system possesses low impartiality, or where there is popular observance of the law. We also recognize the possibility of reverse causality. We find that the magnitude of the impacts increases when controlling for the issue of endogeneity.

Our findings suggest novel and important implications for economists and policy makers promoting the banking sector’s internationalization. The formation of cross-country bank linkages is more straightforward if home-country banks target partners in host countries that have a close physical and financial market development, and cultural distance. Moreover, authorities seeking to promote better networks between home-country and host-country banks should focus on issuing policies that promote institutional stability in the home country. The home country can attain this goal by imposing stringent controls on corruption and improving the stability of the government vis-à-vis international investors’ risks, by improving the impartiality of the legal system or managing internal conflicts and ethnic tensions.

The remainder of this paper is organized as follows. Section 2 discusses the related literature, Section 3 presents the model’s development, while Section 4 outlines the empirical results and conclusions.

Section snippets

Determinants of global bank linkages

The literature is replete with studies on banks’ global linkages. Portfolio theory (Walter, 1981; Buch et al., 2014; Bruno and Shin, 2015) and the theory on the exogenous structure of foreign bank operations (Dell’ariccia and Marquez, 2010; Niepmann and Schmidt-Eisenlohr, 2013) have proved very useful in explaining banking internationalization. The global banking network has expanded to minimize firms’ expected costs (De Blas and Russ, 2013), satisfy firms’ demand for differentiated products (

Methodology

We specify the following model to estimate the effect of cultural distance on bank linkages.Linkijt=β0+β1CultureDij,t-1+β2CONTROLij,t-1+vt+λi+γj+αij+εijt,where i and j denote the source and target country, respectively, and t denotes the year. Variables vt, λi, γj, and αij represent the year, source-country fixed, target-country fixed, and pair fixed effects, respectively. Link reflects the bank linkages of country i and country j. We defined these variables based on Caballero et al. (2018). Cul

Data

The distribution of cultural distances and bank linkages is plotted in Fig. 1, Fig. 2. Fig. 1 shows that the cultures of Egypt, India, Pakistan, Peru, and Switzerland are quite different from those of other countries. The average bank connections considerably vary between the source and target countries. Germany, Hong Kong, the UK, and Singapore have the highest number of lending relationships, while Korea, Turkey, Italy, and Russia have the highest number of borrowing relationships.

The values

Conclusions and policy implications

A complex concept of culture and cultural distance engendering information asymmetry and animosity caused difficulties in earlier studies, including our understanding their effects on various issues, such as the formation of international bank networks. This study overcame these difficulties by examining the nexus between cultural distance and cross-border banking connections. It followed Schwartz (2006) to measure cultural distance, and used the number of bank pairs involved in cross-border

Acknowledgement

This work was supported by the National Economics University, Hanoi, Vietnam [grant number 386/QĐ-ĐHKTQD].

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