Trade and Capital Openness: Impact on Bank Net Interest Margins, Lending and Risk-Taking Behavior

Abstract

This paper is a contribution to ‘interest groups theory of financial development’ based debate that trade- and capital-openness are helpful for financial development. We extend this debate by examining the impact of trade- and capital-openness on net interest margins (rents), gross loan ratios (lending), and risk-taking behavior of incumbent financial institutions. Analyzing a sample of 287 key banks from 37 emerging countries, we find robust evidence that higher trade-openness cause a decrease in average bank net interest margins, an increase in average bank gross loan ratios and a decrease in average bank insolvency risk. We find limited support for the role of capital-openness however. For bank net interest margins, we find that higher capital-openness is effective in reducing average net interest margins of key banks only when considered jointly with trade-openness, but not independently. For bank gross loan ratios and risk-taking, we find that higher capital-openness causes a decrease in average bank gross loan ratios and an increase in average bank risk-taking in emerging economies. Together, our findings support that trade-openness is an effective tool for increasing banking sector development in emerging economies. However, emerging economies must be cautious while opening capital accounts because higher capital-openness although causes a decrease in rents of incumbent financial institutions but it increases overall fragility of key banks.