Foreign Bank Entry and Business Volatility: Evidence from U.S. States and Other Countries

Abstract

The first-order effects of relaxed bank entry restrictions have been favorable, both within the U.S. and across countries. Internationally, the benefits of foreign entry seem to depend on the level of development, but at least for developing nations entrants are more efficient than incumbent banks and the stiffer competition seems to improve overall bank efficiency. In contrast to these first-order effects, the stability implications of increased entry are less obvious. This paper investigates whether greater integration resulting from foreign bank entry has been associated with more or less business cycle volatility. We approach the topic with mix of theory and evidence from both the U.S. states and countries. While theoretical effects are mixed, the empirical effect of relaxation of restrictions of cross-state banking has been to stabilize state-level fluctuations in the U.S. Applying a related set of tests to a panel of about 100 countries, however, we find no evidence that expansion of foreign banking has reduced business fluctuations. If anything, the evidence points tentatively in the other direction.