Financial Crises & the Presence of Foreign Banks - World Bank

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Financial Crises & the Presence of Foreign Banks - World Bank

21problem in Indonesia. Here, however, impediments to foreign ownership meant that thegovernment generally had to acquire the failed banks.In both the government ownership and owner-management situations, transfer ofthe affected banks to foreign ownership may be correlated with a decline in total loansoutstanding in the banking system. One reason is an artifact of the rescue itself and theother is a consequence of the change in ownership.To make a failed bank saleable, whether it is government owned or owner-managed,the regulatory authorities generally must first strip it of its worst assets, putting them into anasset recovery unit. Any comparison of the failed bank before and after the advent offoreign ownership will show a decline in the size of the loan book, but the direction of thecausality is from reduction to the change in ownership, not vice-versa. Also the comparisonconceals the fact that the accounts, by not marking the loans to their salvage value,overstated the loans outstanding before transfer. Still, foreign ownership will automaticallybring a change in lending policy, completely apart from any effect of more stringentstandards. The result will be that the new owners will reduce or even stop their lending tomany of the acquired bank’s traditional customers. Until the bank can develop a newcustomer base, something that may take time, especially when the host country economy isin recession, the size of the loan book will drop and investments in securities, such asgovernment bonds, will increase.There is one situation where foreign bank entry is likely to increase the likelihood ofcrisis even though the entry generates an expansion of credit. The problem occurs when theentry disrupts a cartel. One technology for protecting depositors is to reduce the probabilityof banks failing. Governments frequently accomplish this by permitting banks to cartelize.In their insightful paper, Breton and Wintrobe (1978) explain moral suasion as an exchange

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