When Openness Hurts: How Bank Concentration Blocks Credit After Liberalization

🔎 Why Financial Structure Matters for Liberalization

A theory is tested that the internal structure of the financial sector conditions whether capital account liberalization expands or restricts access to credit. When the banking sector is highly concentrated, banks and aligned governments are more willing and better able to suppress domestic liberalizing reforms—and to coordinate with one another—to reap the private benefits of financial openness. When the financial sector is diffuse, that capacity and willingness to repress reforms is weaker.

📊 How the Evidence Was Assembled

A panel dataset of Latin American and Caribbean countries is used to evaluate the theory. Outcome measures and reform indicators examined include:

• Loans to private firms and households
• Loans to governments and state-owned enterprises (SOEs)
• Changes in entry barriers for banks
• Use of directed credit programs
• Banking sector supervision and regulatory reforms

📈 What Was Found

• In highly concentrated financial systems, capital account liberalization is associated with a decline in lending to private firms and households and an increase in lending to governments and SOEs.
• In diffuse financial systems, capital account liberalization is associated with reforms that lower entry barriers, reduce directed credit programs, and strengthen banking supervision.
• Those reforms in diffuse systems translate into improved access to credit for private firms and households; the opposite distributional shift appears in concentrated systems.

💡 Why It Matters

These results show that the domestic shape of the financial sector crucially conditions the effects of capital account openness. Policy debates about financial liberalization should account for bank concentration and the political capacity of banks and governments to shape domestic financial policy; otherwise liberalization can produce sharply different credit outcomes across countries.