Foreign Banks in Poor Countries: Theory and Evidence





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    • Detragiache and Tressel are at the IMF. Gupta is at the Delhi School of Economics. The authors would like to thank an anonymous referee, Thorsten Beck, Stijn Claessens, Simon Johnson, Sole Martinez Peria, Raghu Rajan, Arvind Subramanian, and participants at the joint World Bank/IMF Seminar, the Paris School of Economics lunch seminar, the 2006 Annual Research Conference of the IMF, and the 2006 Financial Intermediation Research Society Conference for very helpful comments. We are also greatly indebted to Ugo Panizza and Monica Yañez for sharing their data on bank ownership. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy.


We study how foreign bank penetration affects financial sector development in poor countries. A theoretical model shows that when domestic banks are better than foreign banks at monitoring soft information customers, foreign bank entry may hurt these customers and worsen welfare. The model also predicts that credit to the private sector should be lower in countries with more foreign bank penetration, and that foreign banks should have a less risky loan portfolio. In the empirical section, we test these predictions for a sample of lower income countries and find support for the theoretical model.