Foreign penetration, competition, and credit risk in banking

Abstract

This paper reveals that foreign penetration in terms of assets and branches exhibits different impacts on credit risk in banking. In general, a higher share of foreign banks’ total assets exacerbates nonperforming loans, but the increased number of foreign banks diminishes credit risk. Moreover, the role of foreign banks in mitigating credit risk is conditional on the measure of bank competition and country income status. A higher share of foreign bank branches can diminish nonperforming loans after bank concentration, not bank market power, exceeds a certain level. These findings are more pronounced for emerging markets. In addition, higher bank credit risk due to foreign penetration and bank competition can partly be explained by the loss-leader hypothesis coming from higher bank noninterest income. Providing incentives for the banking industry to avoid cross-selling strategies in boosting noninterest income is necessary due to changes in foreign penetration and competition in banking. Keywords: Foreign bank penetration, Bank competition, Credit risk, JEL classification: G21, G28