Foreign penetration, competition, and financial freedom: Evidence from the banking industries in emerging markets

Traditional theories suggest that foreign entry intensifies competition and improves efficiency in a banking sector. However, the positive impacts may be offset by several factors, such as foreign banks' "cherry-picking" lending practice, mergers & acquisitions, and the "crowd-out" effect. Based on a sample of commercial and savings banks collected from Bankscope, this paper investigates the effects of foreign penetration on bank competition in the host countries. Using the two-step Arellano-Bond system GMM method, we show that the entry of foreign banks enhances competition in the banking systems among the sampled developing countries between 2000 and 2014. The positive relationship between foreign penetration and banking competition is more conspicuous after the 2008-2009 global recession. Latin American countries appear to benefit more from foreign bank penetration during the sample period than emerging markets in Asia. Also, the level of a host country's financial freedom has a moderation effect on the "foreign penetration-competition" nexus.