Foreign bank entry and economic growth in Thailand

Abstract

A new guideline for equity holding announced in 1997 has increased foreign participation in Thai banking sector. According to the Financial Sector Master Plan, the Bank of Thailand plan to further lower the impediments to entry of foreign banks in subsequence phases although costs and benefits of this approach are still controversial. This study therefore analyzes the relationship between entry of foreign banks and economic growth by constructing and analyzing a theoretical model with oligopolistic banking sector. The result of our model is two-folded:(1) entry of foreign banks reduces overall costs and interest rate on loans. As a result, firms are able to obtain cheaper financial resources and thus increase production; (2) On the other hand, under circumstances that a number of foreign banks exceed a critical value, domestic banks would face negative profits and are hence bailed out from the market. Even though the domestic banks can compensate their losses and remain in the market, economic growth is still negative. Using Thai data between 1993 and 2004, our empirical estimation confirms that the relationship between foreign entry in banking sector and economic growth are positive. From the study, we agree that encourage economic growth could be encouraged by foreign bank entry but there should be adequate monitoring to decide appropriate level of foreign participation. Besides, we suggest that Thailand gradually liberalize banking sector in that domestic banks improve their competitiveness in preparation for a higher competition and hence additional foreign banks could be allowed to enter the market to further foster efficiency.