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This paper examines the implications of foreign bank penetration on economic growth from the perspective of resource allocation in host countries. We use aggregate banking data, constructed from bank-level balance sheet and income statement information covering more than 1200 banks in the 35 emerging economies of Asia, Latin America and Eastern and Central Europe for the period from 1996 to 2003. By applying pooled OLS and fixed effects estimators, we present consistent evidence that the effect of gross fixed capital formation on output growth is higher in an economy with a more pronounced level of foreign bank penetration relative to an economy with a lower level of foreign bank penetration. This finding suggests that foreign banks play an important role in allocating capital in a more productive way, thus leading to a higher economic growth rate. One of the main policy implications of our findings in this paper is that foreign banks may serve as a channel in enhancing the economic integration of emerging economies with the advanced economies that are home countries of foreign banks. [ABSTRACT FROM AUTHOR]

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