In an effort to develop an efficient and competitive financial system, many countries have liberalized financial services, especially the banking sector since 1960’s. Many countries want to enhance their banking sector so they decided to liberalize their financial sector. Over the last decade many economies are liberalizing their financial sectors, including opening up their banking systems to foreign competition to enhance their domestic banking sector efficiency. Policymakers have come to realize that the presence of foreign financial service providers can benefit the consumers, the financial industry, and the economy all together. One of the reasons for undertaking this policy by the policy makers in many countries was the much-needed funds that foreign investors might bring in host countries to help recapitalization of the banking systems in the Asian crisis of 1997-98.
In many countries especially in less developed countries (LDCs), the presence of foreign banks has increased dramatically, particularly during the 1990s (IMF, 2000). Foreign banks increased the efficiency level of domestic banks. Among other things, these increases in foreign bank operations are due to the fact that since the early 1990s many countries have implemented financial liberalization policies, allowing foreign banks to set up branches and allow domestic banks to be foreign.
Foreign bank entry refers to a process by which foreign banks set up their operations in a host country mainly by either opening up a branch or a subsidiary. Foreign banks have better technology, management, economies of scale, risk-diversification opportunities, supervision, less corruption potential.
Cross country evidence show that foreign bank entry leads to lower interest margins and cost for domestic banks. Moreover, foreign banks are more profitable and efficient than domestic banks. While individual country evidence shows that foreign banks usually lend mostly to large organizations/ corporations or to the government. They pay very less attention to SMEs. Moreover, foreign banks have a safer loan portfolio and flexible loan conditions as compare to domestic banks.
Although the foreign bank’s entry is increasing since last decades, but beside that increased presence of foreign banks raises questions about their effects on the domestic banking sector. The entry of foreign banks may improve the quality and availability of financial services in the host banking market by increasing competition, offering modern banking and management skills and new technologies encourage the development of the domestic bank supervision and most importantly foreign banks enhance a country’s access to international capital markets.
Levine (1996) argued that foreign banks may improve the quality and availability of financial services in the domestic financial market. They can increase bank competition, and present more modern banking management skills and technology, supply better human capital and...