Transfer of reputation: Multinational banks and perceived creditworthiness of transition countries

How do international investors evaluate sovereign borrowers whose histories and institutions are too new or weak to send strong signals about their creditworthiness? In this paper, I suggest that the perceived creditworthiness of many transition countries' governments rests on a 'transfer' of good reputation from prestigious multinational banks, as foreign direct investors. The entry of reputable foreign banks into a transition country signals to international financial markets about the financial strength of that host economy. It also involves the transfer of the status of lender of last resort to the foreign parent bank. Foreign bank penetration can thus create optimistic expectations about a host country's capacity to service its sovereign debt. Using panel data for 23 transition economies during the period of 1996-2009, my empirical results provide support for the argument stressing the exogenous role of foreign financiers as enhancers of the credibility of host country governments. The results are robust to instrumental variable analysis and the inclusion of number of controls for alternative determinants of investors' perceptions of country risk. This proposition is further backed by evidence from three transition countries: Hungary, Estonia and Ukraine.