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International banking can be viewed as a situation where by different banks raise capital at their home markets and then opt to lend it abroad. One of the factors that affect this is the differences in the endowments of factors across different countries. Banks have largely expanded their activities across borders, a move that occurs in different ways. The first way is where by the banks invest more of their capital in foreign countries and the other way is the fact that they intermediate their capital locally in foreign markets (Alloy, 2005).
There exist many causes that give rise to the expansion of banks across borders. Banks can be viewed as vehicles of the flow of the international capital thus providing intermediation services. Due to the differences in a countries factor endowments and the technology that is used in banking, there will arise international banking and global banking. Global banking can be defined as a move where a bank intermediates their capital local in the foreign markets (Deak, 1984). It is evident that this expansion that occurs across borders and is facilitated by the availability of this differences in the rates of return to capital across the different countries. A foreign bank activity may also result from a motive to diversify lending, a move that can foster the efficient capital allocation and lead to an increment in the banking sector efficiency. If there arises any financial frictions, a wedge between the gross return to the capital and the financial interest rate will be driven (Hughes, 2002). The lower the countrys banking sector efficiency, the more the depression of the financial interest rates that are relative to the marginal product of capital.
If integration between two countries differing with respect to their relative endowments of labor and capital and the efficiency of the banking sector occurs, the banking across borders will occur at the same time. Banking across borders enhances efficient allocation of the capital between participant countries thus leading to an improvement to the overall efficiency of the banking sector (Lewis, 1987). The difference in the country level bank efficiency gives rise to global banking a term that is also associated with banking across borders. It is therefore evident that the importance of global banking and international banking largely depends on the efficiency and endowment characteristics of the countries that are integrating. It is also clear that when the difference in endowments between countries facilitates international banking whereas the difference in efficiency of banking sector facilitates global banking. Banks take centrally the role of cross border capital flows in many countries all over the world. They also have international exposures through other channels (Martin, 2007).
As a result of the consequences in the difference in endowments and efficiency, there arises a variation between the service fee and the autarky financial interest rate between the foreign banks and the domestic banks (Thadden, 1992). In case entrepreneurs have to choose between raising capital from domestic or foreign banks, they put into consideration the banks that demand a low interest rate and a low service fee 9Walker, 2001). Due to this, advantage goes to the banks which are located in a country which capital is abundant and which will offer cheap capital to them. They also go for those that are more efficient (Mullineux, 2003).
In addition, different nations conduct international trade because of different reasons. One of the reasons is that resources are not equally distributed to all trading nations thus sparking this trade. However, international markets are not doing well as expected since many countries seem to be trading too much with themselves, while they also invest a lot in themselves. Price differentials seem too large for cross-border trading. International sharing sectors serves to play a major role in increasing the international trade (Ruissakis, 1983). Many efforts are been put in place by the different states so as to promote free trade and also reduce trade barriers, one example is the (GATT) General Agreement on Trade and Tariffs reflected by the eight successive negotiating rounds, which helped establish a multilateral trading system in 1995 (WTO) World Trade Organization, which has led to not only to the reduction of barriers to trade in goods but also went ahead to liberalize capital flow and services among this different states (Santos, 2006).