Drivers of cross-border banking since the Global Crisis

Franziska Bremus, Marcel Fratzscher 28 January 2015

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Since the Global Crisis, international credit markets have become more segmented. Figure 1 illustrates the development of cross-border bank claims over the last years; after a continuous and steep increase, the Crisis has led to a retrenchment in cross-border bank lending. Yet, international lending has evolved heterogeneously across regions. While cross-border lending to developing and emerging economies has increased again, foreign bank claims to developed countries have rather continued to decrease.

Figure 1. Total foreign claims of BIS reporting countries, in trillion USD

Source: Bank for International Settlements, Consolidated Banking Statistics, immediate borrower basis.

Even if part of the retrenchment in cross-border bank claims was cyclical, part of the adjustment seems to be structural as the economic recovery did not go along with a notable increase in total foreign bank claims.

What role do policy changes play for adjustments in cross-border bank claims?

The adjustments in international bank lending have led to a debate on how recent policy interventions have affected international capital flows in the aftermath of the crisis.

  • On the one hand, different observers stress the role of changes in financial regulation for the international activities of banks.

After the experiences of the recent Crisis, national regulators may aim at a lower degree of banking globalisation to facilitate the resolution of large, internationally active banks, and hence to better protect taxpayers from potential losses (The Economist 2012). Using bank-level data for the UK banking sector, Rose and Wieladek (2011) have analysed the implications of bank nationalisations for international lending. They present evidence that foreign banks that profited from government support have cut back their lending to the UK. Thus, part of the retrenchment in international bank lending may be due to increased financial protectionism since the crisis.

  • On the other hand, the effects of monetary policy on capital flows – especially to emerging markets – have been intensely debated.

Among others, Bernanke (2013) has pointed out that in an environment of low interest rates, banks may tend to lean their foreign activities towards higher-yielding markets. Nier and  Saadi Sedik (2014) point out that managing the large and volatile capital inflows since the Crisis has been costly for emerging markets.

In a recent study (Bremus and Fratzscher 2014), we add to this debate by investigating the effects of policy-related drivers of changes in cross-border bank lending since the Global Crisis.

  • The first question we address is how shifts in banking regulations have affected international bank lending in the wake of the Crisis.

As illustrated by Figure 2, bank capital regulation has, on average, become stricter since the Crisis. In general, tighter regulatory requirements may have different implications for banks’ international lending business. An increase in capital requirements in the source country of cross-border credit may lead to a reduction in credit outflows if banks cut back risky foreign lending activities in order to deleverage. However, stricter regulations in the source country could also lead to an increase in foreign lending activities to countries where regulation is more lenient. Using data from the pre-crisis period, Houston et al. (2012) indeed find that differences in banking regulation are important push and pull factors of cross-border bank lending; banks are attracted by countries with a less restrictive regulatory environment.

Figure 2. Average capital stringency index before and after the Crisis

Note: The capital stringency index takes on values between 0 and 7 with higher values indicating stricter bank capital regulation. The graph shows average index values for 135 countries from the dataset by Barth et al. (2013).

In order to study policy-related drivers of changes in international lending between the pre- and the post-Crisis period, we use bilateral credit data for 46 countries from the Bank for International Settlements for the period 2005-2012.[1] Information on capital stringency, supervisory power, and supervisory independence is available from Barth et al. (2013). Following the literature, the years until 2007 can be classified as the ‘pre-crisis’ period, while the years as of 2010 are classified as the ‘post-crisis’ phase. We use a cross-sectional regression model where all variables are expressed as the change between the average across 2005-2007 and the average across 2010-2012.

  • Our results indicate that regulatory policy has been an important driver of adjustments in cross-border banking since the Global Crisis.

Source countries of bilateral credit which have seen a larger increase in supervisory power or independence have extended more cross-border credit. Put differently, the more independent or powerful supervisors got, the less severe was the reduction in cross-border credit in the aftermath of the Crisis. Another interpretation for this result is that stricter regulation in the source country has led to more cross-border lending due to regulatory arbitrage.

With respect to bank capital regulation, the estimation results are similar when the whole country sample is considered. Yet, the larger the differential in capital stringency between the source and the recipient country of cross-border credit in the Eurozone got, the lower the increase (or the larger the reduction) in cross-border lending between these countries.

  • In a second part, we examine which role expansionary monetary policy – as measured by reserve deposits of commercial banks held at central banks – has played for bilateral cross-border lending.

Aggregate reserves at central banks reflect the size of monetary policy interventions (Keister and McAndrews 2009). The more accommodative monetary policy has been since the Crisis, the larger was the increase in total reserves. The estimation results reveal that a larger expansion in source countries’ reserve deposits have come along with smaller reductions (or, larger increases) in credit outflows. Hence, the findings suggest that monetary policy has mitigated credit market fragmentation in the aftermath of the Global Crisis.

Concluding remarks

Our results show that regulatory and monetary policy changes have been important drivers of adjustments in cross-border bank lending since the crisis. While expansionary monetary policy measures have mitigated credit market fragmentation, regulatory policy changes have had mixed effects, depending on the measure and region considered.

More independent and powerful supervisory authorities tend to promote international lending. Our findings indicate that capital regulation should be adjusted in a harmonised and transparent way in order to avoid distortionary lending behaviour, especially in the Eurozone.

References

Barth, J R, G Caprio, and R Levine (2013), “Bank Regulation and Supervision in 180 Countries from 1999 to 2011”, Journal of Financial Economic Policy, Vol. 5(2), pp. 111-219, April.

Bernanke, B S (2013), “Monitoring the Financial System”, Speech at the 49th Annual Conference on Bank Structure and Competition sponsored by the Federal Reserve Bank of Chicago, 10 May, Chicago.

Bremus, F and M Fratzscher (2014), “Drivers of structural change in cross-border banking since the Global Crisis”, Journal of International Money and Finance, forthcoming.

The Economist (2012), “The retreat from everywhere”, 21 April.

Houston, J F, C Lin, and Y Ma (2012), “Regulatory Arbitrage and International Bank Flows”, Journal of Finance, LXVII (5): 1845-1895.

Keister, T and J McAndrews (2009), “Why are Banks Holding so Many Excess Reserves?”, Federal reserve Bank of New York Staff Report No. 380, July.

Nier, E W and T Saadi Sedik (2015), “Determinants of capital flows to emerging markets and the global financial cycle”, VoxEU.org, 4 January.  

Rose, A K and T Wieladek (2011), “Financial Protectionism: the First Test”, NBER Working Paper 17073, Cambridge, MA.

Rose A K and T Wieladen (2011), “Financial protectionism”, VoxEU.org, 29 May.

Footnotes

[1] These countries are Armenia, Austria, Belarus, Belgium, Bosnia and Herzegovina, Brazil, Bulgaria, Canada, Colombia, Costa Rica, Croatia, Denmark, Ecuador, El Salvador, Finland, France, Germany, Ghana, Greece, Guatemala, Honduras, Hungary, Indonesia, Italy, Kenya, Latvia, Lithuania, Malaysia, Mauritius, Mexico, Moldova, Netherlands, Nigeria, Pakistan, Poland, Portugal, Romania, Russia, Slovakia, Slovenia, South Korea, Spain, Thailand, Turkey, Ukraine, United States.

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Topics:  Global crisis International finance

Tags:  cross-border banking, global crisis

Postdoctoral researcher in the Departments of Macroeconomics and Forecasting, DIW Berlin

President, DIW Berlin; Professor of Macroeconomics and Finance, Humboldt-University Berlin; and Member of the Advisory Council, Ministry of Economy of Germany

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