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How does foreign entry affect the domestic banking market?

  • Claessens, Stijn
  • Demirguc-Kunt, Asli
  • Huizinga, Harry

Banking markets are becoming increasingly international through financial liberalization and general economic integration. Using bank-level data for 80 countries for 1988-95, the authors examine the extent of foreign ownership in national banking markets. They compare net interest margins, overhead, taxes paid, and profitability of foreign and domestic banks. The comparative functions of foreign banks and domestic banks is very different in developing and industrial countries, possibly because of a different customer base, different bank procedures, and different regulatory and tax regimes. In developing countries foreign banks tend to have greater profits, higher interest margins, and higher tax payments than do domestic banks. In industrial countries it is the domestic banks that have greater profits, higher interest margins, and higher tax payments. It is common to read, in the literature on foreign banking, that the entry of foreign banks can make national banking markets more competitive, thereby forcing domestic banks to operate more efficiently. The authors show that increasing the foreign share of bank ownership does indeed reduce profitability and overhead expenses in domestically owned banks - so the general effect of foreign bank entry may be positive. Interestingly, the number of foreign entrants matters more than their market share, suggesting that they affect local bank competition more on entry rather than after gaining a substantial market share. These effects hold even when controlling for the fact that foreign banks may be attracted to markets with certain characteristics, such as low banking costs.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1918.

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Date of creation: 01 May 1998
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Handle: RePEc:wbk:wbrwps:1918
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  1. Gary Gorton & Richard Rosen, 1994. "Corporate Control, Portfolio Choice, and the Decline of Banking," Center for Financial Institutions Working Papers 95-09, Wharton School Center for Financial Institutions, University of Pennsylvania.
  2. Ross Levine, 1997. "Financial Development and Economic Growth: Views and Agenda," Journal of Economic Literature, American Economic Association, vol. 35(2), pages 688-726, June.
  3. Demirguc-Kunt, Asli & Huizinga, Harry, 1998. "Determinants of commercial bank interest margins and profitability : some international evidence," Policy Research Working Paper Series 1900, The World Bank.
  4. Goldberg, Lawrence G. & Saunders, Anthony, 1981. "The determinants of foreign banking activity in the United States," Journal of Banking & Finance, Elsevier, vol. 5(1), pages 17-32, March.
  5. Schranz, Mary S, 1993. "Takeovers Improve Firm Performance: Evidence from the Banking Industry," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 299-326, April.
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