A study by Linda Goldberg in the Federal Reserve Bank of New York’s forthcoming Economic Policy Review discusses the effect of soaring foreign direct investment (FDI) in the financial sectors of developing countries, concluding that in several respects such investment is beneficial to the countries that receive these investments.
In Financial Sector FDI and Host Countries: New and Old Lessons, Goldberg explains that financial sector FDI, a relatively new phenomenon, takes the form of banks in industrialized countries with highly developed financial systems (primarily the United States, Spain and the United Kingdom) establishing branches and facilities in developing countries.
Goldberg argues that financial sector FDI has many of the same implications for economies that have already been documented for investments in manufacturing and resource-intensive sectors. According to the author, heightened competitive pressure is one factor that may spur local firms to use resources more effectively, resulting in higher rates of technology transfer and diffusion as well as greater wages, among other benefits.
She finds that financial sector direct investment also is typically associated with greater efficiency, both in more market-based allocation of loans and other investment capital as well as in operations. Moreover, Goldberg’s analysis suggests that the presence of bank branches from nations with highly developed financial systems brings with it exposure to best practices that can result in institutional strengthening on the part of the host country in important areas such as bank supervision.
The author concludes that evidence suggests that the benefits of financial sector FDI can be substantial enough for a country to encourage and support entry from well-regulated and healthy banks.
Linda Goldberg is a vice president at the Federal Reserve Bank of New York.