Abstract:  This study examines the impact of financial liberalization and foreign bank entry on the domestic banking sector from 1996 to 2007, and builds upon and expands the work of Lee (2002).

We find that foreign bank entry, financial liberalization, ownership structure and degree of openness of foreign bank entry positively impact domestic banking system operating efficiency, capitalization, risk management, long-term soundness, financial performance as well as economic and financial development.

However, foreign bank entry is associated with reduced profit margins and increased operating costs of domestic banks in countries with less developed capital markets. Empirical evidence seems to support the argument that foreign bank presence leads to better allocation of capital and eliminates connected lending practices.