Do Foreign Banks Drive Foreign Currency Lending in Central and Eastern Europe?

Foreign direct investment (FDI) by banks into Central and Eastern Europe (CEE) has increased considerably, resulting in foreign bank ownership of up to 90% in some countries in the region. Most CEE countries also recorded a substantial rise in foreign currency (FX) denominated credit, leading to concerns about the potential risks of asset deterioration in the domestic banking sector and of accusations about foreign banks "exporting" risks. While there is a lot of research on dollarization in emerging markets, empirical evidence about the role of foreign banks in promoting fx-lending in CEE is scarce. This paper aims at filling this gap, analyzing whether there exists a significant relationship between foreign banks' asset share and the level of fx-lending. Using a linear regression model with data on 16 transition countries for the period 1999 to 2006 we find that foreign banks do not increase the risk of foreign currency lending. Our results show that foreign currency denominated lending seems to be a function of the level of fx-deposits, changes in the real exchange rate and the concentration of the banking sector.