All banks great, small, and global: Loan pricing and foreign competition

Using a new model of heterogeneous, imperfectly competitive lenders and a simple search process, we show how endogenous markups (the net interest margin commonly used to proxy lending-to-deposit rate spreads) can increase with FDI while the rates banks charge to borrowers remain largely unchanged or actually fall. We contrast the competitive effects from cross-border bank takeovers with those of cross-border lending by banks located overseas, which in most cases reduces markups and interest rates. Although both types of liberalization can increase the cost-efficiency of lending in the liberalizing country, the distinction arises because opening toward cross-border lending increases competitive pressures (contestability) in the credit market, while takeovers do not. Both policies can increase aggregate output and generate permanent current account imbalances. (C) 2012 Elsevier Inc. All rights reserved.