Essays on foreign bank penetration in emerging economies

Foreign bank penetration in emerging economies has been rising rapidly since the 1990s. This thesis examines its effects on host macroeconomic stability, the transmission of monetary policy through the bank lending channel, and its effects on the output in the host countries.The first essay develops a general equilibrium model to address the propagation of external and internal shocks and the effectiveness of monetary policy in two alternative scenarios: an economy dominated by domestic banks and an economy dominated by foreign banks. By applying numerical simulation methods, we find that an economy with the foreign bank-dominant banking sector is associated with lower loan interest rates, more credit, and higher output, wage and employment, compared to a domestic bank-dominant economy. Moreover, the foreign bank-dominant economy is shown to be less responsive to changes in domestic monetary policy. Overall we conclude that foreign banks play the role of a stabilizing force in the host economies, but the effectiveness of monetary policy is reduced due to the presence of foreign banks in these foreign bank-dominant economies.The second essay examines empirical evidence of the bank lending channel of the monetary policy by comparing the responses of domestic and foreign banks to domestic monetary policy shocks at the individual bank level. We find evidence for the existence of an active bank lending channel across domestic and foreign banks. Foreign banks are shown to be less responsive to domestic monetary policy shocks. This lower sensitivity to domestic monetary policy by foreign banks can be explained by foreign banks’ access to the internal capital market of their parent banks. The evidence from aggregated data also shows that the effects of monetary policy tend to be buffered in economies with higher foreign bank penetration level.The third essay examines the implications of foreign bank penetration on economic growth though resource allocation in host countries. It finds some evidence that foreign banks tend to have capital better allocated to more productive sectors. The effect of capital growth on output is higher in economies with more pronounced foreign bank penetration level.