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Abstract
This study investigates the impact of foreign-controlled banks on the profitability and efficiency of domestic banks in Korea, as well as the effect of the level of foreign ownership on local bank performance. Increased market penetration by foreign-controlled banks reduces the net interest margin and profitability of domestic banks while increasing their operational efficiency through reduced overhead cost. In addition local banks with greater foreign ownership were found to be less profitable than those with smaller foreign ownership.
Key Words: Foreign-Controlled Banks, Domestic Banks, Bank Performance, Foreign Ownership of Banks, Korea
I. Introduction
The 1997 financial crisis thrust substantial structural changes upon the Korean banking sector, the most salient being increased foreign acquisition of distressed domestic banks. The need to recapitalize these troubled banks coupled with drastic liberalization of restrictions on foreign ownership of local financial institutions gradually increased the number of locally capitalized foreign-owned banks. For domestic banks previously familiar with foreign competition only through foreign bank branches with limited presence and business scope, these developments posed a major challenge that significantly altered the performance and stability of Korean commercial banking.
This study aims to examine the impact of increased foreign ownership of banks in Korea on domestic bank (defined as a locally-owned and controlled bank) performance. Its second section reviews relevant empirical studies on the impact of foreign bank entry on the host banking market, with a focus on emerging market economies. The third explores the motives and macroeconomic circumstances for increased foreign ownership of banks in Korea and compares financial and operational characteristics of foreign-controlled banks (defined as locally incorporated banks under foreign management control) with those of domestic banks.
Drawing on the literature review, the fourth section provides empirical analysis of the effect of recent expansion of foreign ownership and control of Korean local banks on the performance, of domestic banks particularly in terms of their profitability and efficiency. In addition to this regression, it estimates the impact of variation in the relative share (level) of foreign ownership on local bank (defined as a bank, domestic or foreign, incorporated in Korea) performance. The concluding section recapitulates the study's major findings and discusses policy implications.
II. The Effect of Foreign Bank Entry: A Survey of Empirical Studies
Entry of...