Foreign and Domestic Bank Participation in Emerging Markets: Lessons from Mexico and Argentina

Abstract

* The Argentine and Mexican experiences with foreign bank participation are broadly instructive for other emerging markets contemplating an expanded role for foreign banks in their local economies. * A review of bank lending patterns from 1994 through mid-1999 reveals that foreign banks in Argentina and Mexico exhibited stronger and less volatile loan growth than domestic banks. * The asset quality of bank portfolios, and not ownership per se, appears to be the decisive factor behind the growth and volatility of bank credit. * In both Argentina and Mexico, diversity of ownership has contributed to greater stability of credit in periods of crisis or financial system weakness. Over the past decade, numerous financial systems have opened up to direct foreign participation through the ownership of local financial institutions, frequently as a direct consequence of--and as a perceived solution to--financial crises. Significant increases in such foreign participation have characterized the transition experience of Eastern Europe and the post--Tequila Crisis period in Latin America. However, the crisis experience in Asia has been markedly different to date, and is more notable for the limited nature of majority investments by foreign banks, despite the need for large-scale recapitalization of the region's troubled financial systems. Arguments supporting a policy of openness to foreign participation are far from universally accepted. The benefits to emerging markets of foreign participation in domestic financial systems are widely exposited and argued to be broad-based. These arguments are mirrored by a set of concerns over the potentially adverse effects of opening to foreign participation (or at least opening too quickly). There is a shortage of hard evidence to support either side. This article contributes factually to the debate over the opening of emerging markets to foreign participation by exploring the experiences of Argentina and Mexico--two markets that exhibit a significant degree and duration of foreign bank activity. We begin our analysis by presenting the opposing views on the role of foreign-owned banks in emerging markets.(1) Next, we argue that ownership per se is not a reason to expect differences in the lending patterns of domestic and foreign banks; instead, these would arise because lending objectives, funding patterns, market access, and balance-sheet health may vary. We then review liberalization efforts in Argentina and Mexico in the 1990s and examine local lending patterns by foreign- and domestically owned local banks, including state-owned banks. Our goal is to document these banks' relative stability in lending to different client bases and to examine the cyclical properties of such lending. Throughout, we base our analysis on published quarterly loan data for individual banks in Mexico and in Argentina in the 1990s. We look at total lending, personal/consumer lending, mortgage lending, and the broad remaining group that includes commercial, government, and other lending. Econometrically, we show that in these countries behavioral differences are apparent across certain types of banks. These are related to whether a bank is public or private, potentially reflecting the role of distinct lending motives across these institutions. In addition, bank behavior is significantly related to the asset quality of the bank portfolio. In response to some types of economic fluctuations, domestic privately owned banks with low levels of impaired loans can have more volatile lending than their foreign bank counterparts. We argue that these differences among foreign and domestic private banks are plausible and are to be expected, especially if the respective banks rely on alternative sources of funds. Based on bank lending patterns from 1994 through mid-1999, overall we do not find any support for the view that foreign banks contribute to instability or are excessively volatile in their responses to market signals. …