“Lending by Example”: Direct and Indirect Effects of Foreign Bank Entry in Emerging Markets

Using a novel dataset that allows us to trace the primary bank relationships of a sample of mostly unlisted firms in Eastern Europe, we explore to what extent foreign banks can improve the allocation of credit. Our results suggest that the limits of financial integration are less tight than what previous literature based on a static picture of bank loan portfolios suggested. Foreign banks appear to allocate credit more efficiently than domestic banks do. Most importantly, using a propensity score methodology, we show that only in countries where foreign bank presence is limited, firms that (directly) borrow from a foreign bank obtain more financial loans than comparable firms and thus invest more and have higher increases in profitability. In other words, firms seem to benefit from foreign bank presence only if they maintain a direct relationship. In countries where foreign bank presence is large, on the contrary, firms appear to have the same access to financial loans and ability to invest whether they borrow from a foreign bank or not. Thus it appears that foreign banks presence affects domestic banks lending policies and improves access to credit for all firms.