The IMF Working Papers series is designed to make IMF staff research available to a wide audience. With nearly 300 released each year, working papers cover a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
We model an economy in which domestic banks and firms face incentive constraints, as in Holmstrom and Tirole (1997). Firms borrow from banks and uninformed investors, and can collude with banks to reduce the intensity of monitoring. We study the general equilibrium effects of capital flows (portfolio investments and loans, FDI) on the governance of domestic banks. We find that liberalization of capital flows may deteriorate the governance of the domestic financial system by increasing firms' incentives to collude with banks, with negative effects on productivity. We also show that systemic bailout guarantees increase the risks of collusion.