Nº 20-87: Inter-industry FDI Spillovers from Foreign Banks: Evidence in Transition Economies

Too little is known about the inter-industry spillovers from foreign direct investment (FDI) in services. We therefore study whether and how spillovers from FDI in the banking sector occurs. We access a sample of non-financial domestic firms in transition economies from Eastern Europe and Central Asia and find that the innovation pursued by domestic firms benefits from foreign bank penetration. This positive interindustry spillover surprisingly (and in contrast to conventional wisdom) does not seem to work through enhanced credit access, but rather through the improvement of the local market of fee-based banking services and through the transfer of knowledge to domestic firms in non-contractual interactions. These positive spillovers occur mainly for foreign banks that use relationship lending, domestic firms that do not export, and host countries that are less open to the global market.