Financial Globalization and the Governance of Domestic Financial Intermediaries

We model an economy in which domestic banks and firms face incentive constraints, as in Holmstrom and Tirole (1997). Firms borrow from banks and uninformed investors, and can collude with banks to reduce the intensity of monitoring. We study the general equilibrium effects of capital flows (portfolio investments and loans, FDI) on the governance of domestic banks. We find that liberalization of capital flows may deteriorate the governance of the domestic financial system by increasing firms'' incentives to collude with banks, with negative effects on productivity. We also show that systemic bailout guarantees increase the risks of collusion.Governance;Banking;bank capital, foreign banks, fdi, credit market, direct investment, foreign direct investment, bank loans, foreign bank, banking system, bank entry, banking sector, bank borrowing, foreign investment, bankers, foreign capital, segmentation, bank credit, connected lending, portfolio investments, portfolio investment, banking capital, credit constraints, foreign institutions, investment decisions, bank-firm relationships, direct foreign investment, bank finances, medium size, firms ? incentives, banks ? loans, bank distress, banking systems, bank of indonesia, foreign investments, bank behavior, bank earnings, resource allocation, firms ? incentive, foreign-owned firms, bank credit allocation, bank runs, direct foreign investments, bank incentive, banker, bank credit policies, bank-firm relationship, direct investments