Banks can enter new countries either through greenfield entry or by acquiring local banks. I model the effect of a foreign bank's mode of entry on the stability of the local financial sector. Banks exert costly effort when they extend credit. Limited liability creates an agency problem which leads to under provision of effort. I show that the diversification of the foreign bank.s loan portfolio mitigates the agency problem, and permits the foreign bank to extend credit during downturns where the local banks are forced to contract credit. The risk management framework employed by the foreign bank creates a divergence in the behaviour of a greenfield entrant and an acquirer. The greenfield entrant does not own a portfolio of local loans, and therefore, it has a greater risk taking capacity than the acquirer. Thus, competition, and thereby the distortion of the local banks' incentives to exert effort, is greater following greenfield entry than following entry through acquisition.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Publisher Info
Paper provided by Financial Markets Group in its series FMG Discussion Papers with number
dp623.