Does foreign bank presence affect interest rate pass-through in emerging and developing economies?

Abstract

The impact of greater foreign bank presence on domestic monetary policy transmission has become a subject of importance for emerging and developing economies (EMDEs) as several of them have gravitated towards more market determined exchange rate regimes and consequent use of interest rates as the primary instrument for macroeconomic management. In this paper, we explore the impact of foreign bank presence on interest rate pass-through for a panel of 57 EMDEs over the period 1995–2009. Our empirical results suggest that there are strong threshold effects in terms of foreign bank presence and its impact on the strength of interest rate transmission. Foreign bank presence tends to reduce lending rates and enhance interest-rate pass-through in countries that have a relatively high degree of foreign bank presence compared to those with limited presence. On the other hand, foreign banks do not play any significant role in interest rate transmission in low threshold economies. We further find that the when foreign bank presence is associated with a decline in banking competition, it appears to lower the interest rate transmission.