U.S.-Korea Free Trade Agreement: Potential Economy-wide ... - USITC

Previous Literature
The method for constructing TEs in banking services was originally developed by Saunders
and Schumacher 4 and further refined by Kalirajan et al. 5 Saunders and Schumacher regressed
net noninterest operating expenses and capital and liquidity measures on net interest margins
using bank-level data in seven OECD countries. The intercept terms for each country
estimated the country-level pure spread, which is the interest rate spread after controlling for
firm-level and prudential measures. In the second stage, Saunders and Schumacher used
these estimated pure spreads as the dependent variable, with market structure and interest
rate volatility as the independent variables. Kalirajan et al. employed the same basic model
using bank data from 27 countries. The key addition they made to the model was the
introduction of a trade policy variable in the second stage, which allowed for the subsequent
calculation of TEs. The trade policy measure employed was developed by McGuire and
Schuele 6 using countries’ GATS schedules and various other sources. Restrictions are scored
on a scale from 0 to 1 based on their severity, and restrictions are also weighted on their
relative importance. Verikios and Zhang 7 inserted TEs developed by Kalirajan et al. into the
FTAP2 8 model, a CGE model which includes commercial presence. They then computed
welfare effects for a number of regions and countries, including the United States and Korea,
of several multilateral banking liberalization scenarios. They estimate a global GNP increase
of 0.1 percent based on complete global banking liberalization. 9
Conceptual Framework
Restrictions on banking have the effect of shifting up the foreign supply curve in the
domestic banking market. 10 The domestic supply curve is unaffected because the concerned
restrictions are discriminatory in that they are imposed on foreign, but not domestic, banks.
This shift up in the foreign supply curve causes the price of intermediation services, 11 as
measured by NIMs, to increase. 12 The total quantity of banking services supplied decreases,
while the share provided by domestic banks increases and the share provided by foreign
banks decreases. The econometric analysis below estimates the wedge between observed
prices and prices that would exist in the absence of any discriminatory restrictions on foreign
banks. Assuming the domestic banks are able to capture the rents generated from these
restrictions, this wedge may be considered a TE.
4 Saunders and Schumacher, “The Determinants of Bank Interest Margins: An International Study,” 2000,
813–32.
5 Kalirajan et al., “The Price Impact of Restrictions on Banking Services,” 2000, 215–20.
6 McGuire and Schuele, “Restrictiveness of International Trade in Banking Services,” 2000, 201–13.
7 Verikios, and Zhang, Global Gains from Liberalising Trade in Telecommunications and Financial
Services, October 2001, 36.
8 Foreign direct investment and Trade Analysis Project model version 2.
9 The multilateral welfare effects estimated by Verikos and Zhang would not be comparable to expected
welfare effects of banking the banking liberalization resulting from a bilateral treaty, such as the U.S.-Korea
FTA.
10 Deardorff and Stern“Empirical Analysis of Barriers to International Services Transactions and the
Consequences of Liberalization,” 2005, 550–55.
11 Kalirajan et al., “The Price Impact of Restrictions on Banking Services,” 2000, 215.
12 The effect of TEs on NIMs will vary based on the size of a country’s banking sector relative to the total
world banking market. For a small country, the expected price effect should be equal to the TE. For medium
or large countries such as Korea and the United States, the expected price effect may be smaller than the TE.
In addition, markets are assumed to be competitive and foreign and domestic services highly substitutable.
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