Foreign Banks in Poor Countries: Theory and Evidence; Enrica Detragiache, Poonam Gupta, and Thierry Tressel; November 10, 2006

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. JEL Classification Numbers: G21, O16