Three essays in financial liberalization

Financial liberalization throughout the world is associated with a rapid increase in lending through banks' subsidiaries abroad. " Financial Liberalization and the Representation Choice of a Foreign Bank" uses Horstmann and Markusen's (1996) framework to develop a theoretical model of banking that explains the capital allocation choice of a foreign investor in a host bank market. A foreign bank has two approaches to maintain borrower-lender relationships with borrowers in the host country. It can invest through the domestic banking system and delegate monitoring responsibility to the local bank management, or it can open a subsidiary in the domestic market and internalize its monitoring responsibilities. The paper argues that the risk of negligent monitoring by the domestic bank's management may encourage foreign investors to increase their ownership in a host country banking system. Additional incentives for the foreign investor to enter the banking market include monitoring cost advantage of the foreign investor and small capital endowment of the host economy. The paper finds that foreign bank entry is beneficial in a highly productive host economy with an incumbent bank that can sustain rising pressure of monitoring costs.; Financial liberalization resulted in significant credit dollarization in developing and transition economies. "Credit Dollarization in Transition Economies: Is it Firms' or Banks' "Fault"?" investigates the respective contributions of banks and firms to the dollarization of credit. Whether dollarization comes mainly from the financial sector or from the real sector has important policy implications. First, it indicates whether there are balance sheet mismatches in the economy. Second, it shows in which sector of the economy they are concentrated, and which sector (if any) policy makers should target in order to contain the negative effects of exchange rate depreciation. This paper uses a new dataset for twenty-two transition economies for the period 1990--2001. It separates the contributions of banks and firms to credit dollarization by grouping potential determinants into bank- and firm-specific factors. Empirical results provide evidence that bank currency matching is the main driving force of credit dollarization. However, currency mismatches tend to be concentrated in the real sector, and this indirectly exposes the economy to financial crises.; "Currency Mismatches and Banking Crises" is a continuation of the second dissertation chapter. If banks do not match the currency structure of their assets and liabilities, they face exchange rate risk. However, if the currency structure of their assets and liabilities is identical, banks pass the currency risk onto their borrowers. In the end, banks will bear the costs indirectly because they face a higher default risk if the domestic currency depreciates. This paper uses a simple theoretical framework to show that bank runs are determined by currency mismatches in the banking and the real sectors, and unexpected exchange rate depreciation. The econometric results present some evidence that the persistence of banking crises in transition economies is reinforced by too much lending in foreign currency. There is also evidence that banks face direct exchange rate risk even though their open currency positions are very limited.