The Influence of Foreign Bank Presence and Its Funding Structure on Capital Inflows: Evidence from Emerging Economies

This study analyzes the role of foreign banks in stabilizing capital flows. Based on a sample of 81 emerging countries during 1995-2009, we find that the strong presence of multinational bank’s subsidiaries is associated with capital inflows at normal times. In times of crisis, we also find that the relation between capital flows and foreign bank presence importantly depends on subsidiaries’ funding structure. Specifically, we provide the evidence that financial instability should not be attributed to foreign banks in countries where subsidiaries rely more on local deposit funding. On the contrary, subsidiaries’ cross-border borrowing may exacerbate both the transmission of the systemic shock and adverse effect of the country-specific shock. The policy implication is that national supervisory institution should regulate subsidiaries’ cross-border borrowing rather than entry.