Academic journal article
By Ferraris, Leo; Minetti, Raoul
Journal of Money, Credit & Banking , Vol. 39, No. 4
IN THE LAST two decades several financially liberalized countries, such as the United States, the United Kingdom, the Nordic countries, the East Asian countries, have experienced an aggressive entry of new lenders into their credit markets. Cross-border lending has played an important role in this process. Japanese banks increased their presence in the United States during the 1980s and in East Asia during the 1990s (Peek and Rosengren 2000a). In the United States, after the abolition of interstate branching restrictions by the 1994 Riegle-Neal Act, banks have expanded beyond state borders. This process is likely to continue in the future. In Europe policy makers are considering to relax regulatory and supervisory barriers that inhibit banks' cross-border expansion and the integration of national banking systems. The impact of financial liberalization has had a functional dimension besides a geographic one, with lenders spreading their loan portfolios beyond their traditional area of activity. In the 1980s Nordic and UK banks increased their involvement in the real estate sector. More recently, in several countries, banks granted loans to internet and telecom companies.
The mechanisms through which new (foreign) lenders interact with incumbent economic actors are non-obvious. The entry of lenders into liberalized economies and sectors has allegedly had dramatic effects on firms' behavior and the nature of their projects. According to The Economist (1999), a popular view is that an effect of this entry has been to "increase the riskiness of traditional behavior or introduce new and inexperienced players." Is this view justified? Even less obvious is therefore the impact of financial liberalization on economic stability through lenders' entry. Recent research has identified a pattern in which financial crises tend to be preceded by episodes of financial liberalization, especially in emerging economies (see, e.g., Kaminsky and Reinhart 1999). These studies consider a broad definition of financial liberalization, comprising the opening of the capital account, the liberalization of the securities and stock markets and of the domestic financial system. (1) However, they are substantially silent on the role that foreign or new banks have in the crises. Indeed, there seems to be a discrepancy on this aspect of financial liberalization between the popular view and the extant evidence. On the one hand, concerns have mounted on the possible destabilizing behavior of foreign financial institutions (Dages, Goldberg, and Kinney 2000). For example, Peek and Rosengren (2000b, p. 147) write that "arguments against allowing the entry of foreign banks into domestic markets usually include concerns ... that foreign banks will not serve as a stabilizing influence by providing additional credit during a crisis in the host country." On the other hand, several empirical studies suggest that lending by foreign banks exhibits a less procyclical pattern than that by domestic ones and that foreign banks can enhance output stability. Dages, Goldberg, and Kinney (2000) find that in Mexico and in Argentina in the late 1990s the relative share of foreign lending exhibited a countercyclical pattern. Goldberg (2002) finds that lending by U.S. banks to industrialized countries does not respond significantly to cyclical changes in the fundamentals of the host country, less so than lending by domestic banks. Morgan, Rime, and Strahan (2003) focus on interstate banking in the United States and find a negative correlation between out-of-state bank share and state business volatility. The timing of entry also hints at a stabilizing behavior of foreign banks (see Montgomery 2003 for a review of the evidence). Diamond and Rajan (2001b) find that in the late 1990s in six East Asian countries foreign banks increased their lending after the onset of the crisis. Peek and Rosengren (2000b) and Kraft (2002) disentangle a similar behavior of foreign banks during the 1994-95 Tequila crisis of Argentina, Brazil, and Mexico and during the 1998-99 Croatian crisis, respectively. …