The Real Effect of Foreign Banks

Although foreign banks can act as catalysts for financial and economic development, their role remains controversial because they might displace local lending, thereby tightening firms’ overall access to credit. We study the economic channels through which domestic lending by foreign banks affects real economic activity in a large cross-section of developing and advanced countries. We find that foreign lending alleviates financial constraints and increases real growth net of the competitive reaction of local lenders. In addition to providing stable access to credit, foreign banks also mitigate the consequence of informational and legal obstacles to lending, especially in developing credit markets.