The Differential Impact of Bank Liberalization

In this paper, we investigate the effects of liberalization on banking markets. While some previous studies find a positive impact of liberalization on banking efficiency, other studies point out several adverse effects for domestic banks. In this paper, we explain these diverse findings by showing that the way liberalization affects markets depends on the banks' inherent distance relative to a technology frontier set by foreign owned banks. Banks that operate close to the frontier, generally improve on their efficiency following liberalization. Banks that operate in further distance do not manage to compete with foreign market entrants, therefore, losing from liberalization. Interestingly, we also find that highly efficient banks forfeit some of their competitiveness if their market is not liberalized. These findings suggest that there is no one size fits all policy concerning banking market liberalization.