A Model of Domestic Banking Sector with Foreign Entrants

A Model of Domestic Banking Sector with Foreign Entrants

Lili Zhu

Abstract

This study develops a theoretical framework to examine the short-term impact of foreign entry on domestic banks’ operating behavior and performance in emerging markets. Four hypotheses are proposed to show how overhead costs, interest rate margin, and profits may respond to higher level of banking competition caused by foreign entrants. The model shows that the efficiency impact of foreign entry is affected by the pre-existing competitive environment in the host market. Immediate efficiency gains, if any, are only concentrated in more competitive banking sectors. In future empirical studies, the pre-existing competitive condition can be measured by indicators of contestability, intra-industry competition, and inter-industry competition.

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