Bank globalization and financial stability: International evidence

With a comprehensive dataset covering 129 countries over 1995–2013, this study investigates the impact of bank globalization on financial stability. I find strong evidence that foreign bank entry increases both loan risk and the overall risk of bank failure, and threatens the financial stability of the host country. However, this link is dependent on the regulatory and institutional framework of the host country. The adverse impact from foreign banks can be mitigated when the host country has more restrictions on fee-generating activities, less stringent capital requirement, more asset diversification guidelines, a single supervisor, less government-owned banks, lower market entry barrier, and/or less effective credit information sharing. Instead, foreign bank entry could even lower bank risk when host country regulations on bank activities are highly restrictive, capital requirement is less stringent, and/or market entry barrier is low. The need to improve financial stability and that to reduce the adverse impact of foreign bank entry impose conflicting demand on some bank regulations, thus policymakers need to balance both needs and carefully condition the prudential regulations to ensure financial stability and at the same time minimize the adverse impact from foreign bank entry.