Foreign Entry and the Mexican Banking System, 1997-2007
Executive Summary — What are the effects of foreign bank entry in developing economies? In recent years, governments around the world have been opening up their banking systems to foreign competition. In Mexico, for example, the market share of foreign ownership of banks increased fivefold between 1997 and 2007. In this paper, Stanford professor Stephen Haber and HBS professor Aldo Musacchio describe their detailed study of the impact of foreign entry in Mexico during that period. Overall, results suggest that while foreign entry in Mexico is associated with greater stability of the banking system, it has not increased the availability of credit, and foreign entry is not a solution to a property rights environment that makes contract enforcement costly. Key concepts include:
- Foreign entry in Mexico is associated with greater banking system stability. Foreign entry, however, has not increased the availability of credit.
- Mexican banks that were sold to foreign multinationals were invested in housing loans with a high risk of default and a low rate of interest. Foreign purchasers appear to have shifted the loan portfolio away from these investments.
- However, foreign entry, whether by mergers and acquisitions or by greenfield banks, has not led to an increase in financial intermediation. At the end of 1997, GDP was 18 percent, and 12 years later it had grown to only 23 percent, low by any comparative standard.
- In Mexico, foreign entry is not a solution to a property rights environment that makes contract enforcement costly.
What is the impact of foreign bank entry on the pricing and availability of credit in developing economies? The Mexican banking system provides a quasi-experiment to address this question because in 1997 the Mexican government radically changed the laws governing the foreign ownership of banks: the foreign market share therefore increased five-fold between 1997 and 2007. We construct and analyze a panel of Mexican bank financial data covering this period and find no evidence that foreign entry increases the availability of credit. We also find that switching from domestic to foreign ownership is associated with a decrease in non-performing loans and an increase in interest rate spreads, suggesting that foreign concerns bought domestic banks that had been making loans with low interest rates to parties that had a low probability of repayment. 39 pages