Sectoral Impact of Barriers to Trade in Banking Services: A Cost and Profit-based Approach

This paper identifies the cost-escalating and price-creating effects of trade barriers in banking services. It also explores how prudential regulation reinforces or cancels out the impact of trade barriers on bank performance. Evidence on the determinants of cost and profit changes for 7,321 commercial banks in 28 countries over the period 1997-2006 highlights that trade barriers can affect both costs and prices. The impact of trade barriers is found to depend on the type of restriction. Restrictions on establishment and on-going operation of traditional banking services (TRI) are found to have both cost-escalating and price-raising effects but to be biased towards the former effect. This implies that liberalisation of this type of restriction would be more beneficial to society. However, no evidence is found for the impact of restrictions on banks’ ability to do non-traditional banking services and to expand their business scale. The paper also finds that larger banks gain greater profits but the smaller firms experience higher costs because of trade barriers. The study also discovers some interesting results of how prudential regulation affects the impact of trade barriers. The total capital ratio is observed to mitigate the impact of trade barriers on bank cost but to reinforce its impact on profit. The liquidity ratio is shown to have no effect on the impact of trade barriers on bank cost but to enhance the impact of TRI on revenue. Although the ultimate target of prudential regulation is to preserve the stability and efficiency of the banking sector, this requirement can also be seen as a buffer for banks against trade barriers.