Role of Foreign Capital in Stability of Banking Sectors in CESEE Countries

We investigate whether foreign ownership in the banking sector is a key determinant of its stability in Central, Eastern and South-Eastern European (CESEE) countries, as there is no consensus in the current literature on emerging markets. To this end, we introduce a financial strength index (FSI) as a proxy for financial stability. We used binary regressions for both pooled and panel data to model bank-and country-level data for 20 CESEE countries from 1995 to 2014. Our findings indicate that there is no significant direct link between the share of foreign-owned banks and stability in CESEE banking sectors; instead, financial stability is dependent on banks' credit policies and their balance sheet structures, irrespective of the type of ownership. We argue that positive macroeconomic development drives financial stability in CESEE countries, increases penetration by foreign banks and encourages them to expand through the pursuit of aggressive credit policies. Such policies, rather than the share of foreign capital per se, may have negative impacts on financial stability, exacerbating boom-bust cycles.