Foreign Banks and the Dual Effect of Financial Liberalization
26 Pages Posted: 21 Oct 2009
Date Written: October 20, 2009
In emerging countries, credit market liberalization is often motivated with the financial deepening generated by the entry of foreign financial institutions. However, a gloomier view warns that credit market liberalization can benefit internationally active, export-oriented businesses at the expense of domestic-oriented ones. This paper aims at reconciling these views focusing on the asymmetries between foreign and domestic lenders. We investigate a two-sector economy where foreign lenders are more efficient than local lenders at extracting value from collateral assets, with their efficiency being stronger for internationally tradable assets than for local assets. We find that under some conditions the entry of foreign lenders mitigates credit frictions and raises asset prices and output. However, in other circumstances, despite their higher efficiency, the entry of foreign lenders tightens collateral constraints and depresses the price of non-tradables and output. The reallocation of credit from the nontradables to the tradables sector constitutes the channel whereby liberalization can have a contractionary impact.
Keywords: financial liberalization, credit market, sectoral asymmetries, non-tradables
JEL Classification: F36, E44, G00
Suggested Citation: Suggested Citation