Foreign Bank Entry and Net Interest Margins: Insights from the Rapid Expansion Era in Southeast Europe

This paper investigates the impact of foreign bank entry on financial intermediation costs in host countries, using panel data from nine Southeast European economies during a period of rapid global financial integration (1995–2011). Using a panel framework that exploits within-bank and cross-country variation, supported by an instrumental variables (IV) strategy, we find that foreign banks initially operate with lower net interest margins (NIMs) than domestic banks, suggesting enhanced competition and lower intermediation costs. Over time, however, this effect diminishes, with foreign banks eventually charging higher margins as market integration deepens and risk strategies evolve. We also show that regulatory stringency in banks’ home countries influences their behaviour abroad: banks from more tightly regulated jurisdictions tend to operate with higher NIMs, suggesting a potential for regulatory arbitrage. Our findings offer key lessons for regulators navigating cross-border banking risks amid financial fragmentation and geopolitical uncertainty.