Researchers for the Bank of Canada have found a link between the level of international expansion by Canadian banks and their financial performance.

A new working paper establishes a positive, but weak, relationship between the degree of ‘internationalization’ and bank performance. However, it notes that the banks’ higher returns could simply reflect the fact that they are taking more risk in these overseas operations.

“Our analysis suggests that there is a weak but significant relationship between the degree to which Canadian banks operate abroad and the performance of those banks. The evidence also suggests that this relationship is dependent on the risk profile of the banks’ foreign operations,” the paper explains.

“The positive relationship between DOI and performance does not imply that firms with lagging performance should attempt to increase DOI in order to boost their performance. On the contrary, firms that are doing well domestically are best placed to do well globally,” the paper explains. “For that reason, we expect to see superior performance before firms move abroad. To not explicitly account for this initial success may result in too much significance being attributed to DOI.”

“Our results suggest that if firms decide to move abroad to improve performance, and their decision is based only on the positive relationship between DOI and performance, then such a strategy may not result in improved performance,” it adds. “Furthermore, the link between DOI and firm performance must also take into account the risk profile of the companies’ operations.”

The paper adds that the implication for regulators is that although the international expansion is correlated to bank performance, “they must be careful not to encourage more international activity for the purpose of improving performance. Consequently, regulators must take into consideration the potential impact of how banks allocate their portfolios between domestic and foreign claims, as well as the composition of those foreign claims vis-à-vis risk. Understanding these aspects of Canadian banks’ behaviour will assist regulators to ensure safe and efficient financial markets.”