OPPapers.com

Does Foreign Entry Effect The Domestic Banking Market

How Does Foreign Entry Affect the Domestic Banking Market?

Stijn Claessens, Asli Demirgüç-Kunt, and Harry Huizinga1

Revised: May 1998

Abstract: Using bank level data for 80 countries in the 1988-1995 period, this paper examines the extent of foreign ownership in national banking markets. The net interest margins, overhead, taxes paid, and profitability of foreign and domestic banks are compared. The functioning of foreign relative to domestic banks is very different in developing and developed countries, with foreign banks achieving higher (lower) profits than domestic banks in developing (developed) countries. Estimation results further suggest that an increase in the share of foreign banks leads to a lower profitability of domestic banks.

Keywords: foreign entry, domestic banking. JEL Classification: E44, G21

1

East-Asia and Pacific Region, The World Bank, Development Research Group, The World Bank, and CentER and Department of Economics, Tilburg University, respectively. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. We thank two referees for valuable comments and Anqing Shi for excellent research assistance.

1.

Introduction Recent years have seen an increased importance of international trade in goods and

financial services. To facilitate such trade, many banking institutions have also become international.2 Banks expand internationally by establishing foreign subsidiaries and branches or by taking over established foreign banks. The internationalization of the banking sector is facilitated by the liberalization of financial markets worldwide. Developed and developing countries alike now increasingly allow banks to be foreignowned. Financial liberalization of this kind proceeds on the premise that the gains to domestic market participants from foreign entry...