The purpose of this study is to modify the gravity model to identify the main determinants of the European Union (EU) bank lending to the Central and Eastern Europe (CEE) countries during 1994-2012.
This study uses both two-stage least squares and dynamic generalized method of moments to estimate the modified gravity model.
This study finds that the CEE countries with more developed stock markets have received the higher EU bank lending inflows. The EU banks have greater access to additional financing in the stock markets. Second, the higher stock market difference between the CEE and EU countries has boosted the EU bank lending. Compared to the developed EU stock markets, the less developed CEE stock markets have become more favorable to the EU banks seeking to earn higher profits.
The CEE countries can further boost the EU bank lending inflows through deepening capital liberalization. They should facilitate easy foreign bank entry by reducing excessive bank legislations and regulations. Moreover, they can promote the EU bank lending through substantial EU bank integration. This can accelerate the major bank reform which would facilitate better bank supervision and regulations.
Most previous studies have primarily used the macroeconomic and institutional factors to explain the EU bank lending. In contrast, this study explores the growing importance of the CEE financial development and bilateral trade in explaining the EU bank lending.
