Explaining Foreign Bank Entrance in Emerging Markets
21 Pages Posted: 1 Dec 2008
Date Written: November 30, 2008
This paper provides a theoretical model that explains the empirical observation that foreign banks from industrialized countries tend to increase their involvement in emerging markets during periods characterized by instabilities. In this model, domestic banks have more 'soft' information about their borrowers while a superior screening technology allows foreign banks to obtain more 'hard' information about their borrowers' investment projects. The presented model offers a surprising implication. Contrary to all expectations, foreign banks take over market shares from their domestic counterparts if the economic conditions in the host country deteriorate. Apparently, in times of economic instability 'hard' information becomes relatively more valuable than 'soft' information. Thus, under adverse economic conditions foreign banks have a comparative advantage over domestic banks.
Keywords: foreign banks, integration of banking markets, transition economies, financial stability
JEL Classification: G15, G21, G24, G32
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