A Liberalization Spillover: From Equities to Loans

Xin Liu, Shang-Jin Wei, and Yifan Zhou

The opening of equity markets to foreign investment by developing countries appears to generate an enormously large positive growth effect (Bekaert, Harvey, and Lundblad (2005)) despite a relatively small role of such markets for financing investment in most economies. We propose a spillover channel from equity market opening to lower costs of bank loans, which helps to explain this puzzle. From analyzing bank loan data associated with China’s introduction of the Qualified Foreign Institutional Investors (QFII) program, we find significant support for this channel. Furthermore, we show that a reduction in the risk premium in loans is an important mechanism.