Financial Sector FDI and Host Countries: New and Old Lessons

n the 1990s, foreign direct investment (FDI) became the largest single source of external finance for many developing countries.1 Most discussions on the causes and effects of FDI have focused on flows into manufacturing and real production sectors, where this type of investment has traditionally been concentrated. More recently, however, FDI into the financial sector has soared, and the sector is being reshaped dramatically. Financial sector FDI, a relatively new phenomenon, typically takes the form of banks in industrialized countries establishing branches and facilities in developing countries. Following the dissolution of the Soviet Union, bank entry into Central and Eastern Europe in the early 1990s led to foreign ownership in local banking systems; today, such ownership often exceeds 80 percent of local banking assets. In addition, the liberalization of financial sectors in Latin America was likely spurred in part by foreign direct investment, especially in countries facing potential competitive losses to Asian economies. Within Latin America, the financial crises of the mid-to-late 1990s provided additional opportunities for foreign entry, as countries sought to recapitalize their banks and improve the efficiency of their financial systems.