Internal capital markets and lending by multinational bank subsidiaries

We use new panel data on the intra-group ownership structure and the balance sheets of 45 of the largest multinational bank holdings to analyze what determines the credit growth of their subsidiaries. We find evidence for the existence of internal capital markets through which multinational banks manage the credit growth of their subsidiaries. Multinational bank subsidiaries with financially strong parent banks are able to expand their lending faster. As a result of parental support, foreign bank subsidiaries also do not need to rein in their credit supply during a financial crisis, while domestic banks need to do so.     

The multinational bank: A financial MNC?

The theory of non-financial multinational corporations is applied to the multinational commercial bank. The incentives toward multinationality that characterize the expansion of non-financial firms have their counterparts in multinational banks. The theory of the MNC provides a useful basis for the development of a theory of the multinational bank when the subsidiary offices operate in foreign financial markets. When banks' foreign subsidiaries operate in supranational markets (such as the Eurocurrency markets), there is little or no equivalence because the multinational banks compete only among themselves: there is no competition with indigenous firms. The supranational markets give rise to a distinct type of subsidiary. These banking offices and the markets in which they operate serve to integrate national capital and money markets with some possible endangerment to the stability of the international financial system.     

Foreign Banks in Transition Countries: To Whom Do They Lend and How Are They Financed?

We use focused interviews with managers of foreign parent banks and their affiliates in Central Europe and the Baltic States to analyze the small‐business lending and internal capital markets of multinational financial institutions. Our approach allows us to complement the standard empirical literature, which has difficulty in analyzing important issues such as lending technologies and capital allocation. We find that the acquisition of local banks by foreign banks has not led to a persistent bias in these banks' credit supply toward large multinational corporations. Instead, increased competition and the improvement of subsidiaries' lending technologies have led foreign banks to gradually expand into the SME and retail markets. Second, it is demonstrated that local bank affiliates are strongly influenced by the capital allocation and credit steering mechanisms of the parent bank.     

Foreign bank penetration and the lending channel in emerging economies: Evidence from bank-level panel data

This paper examines the main implications of recently increasing foreign bank penetration on bank lending as a channel of monetary policy transmission in emerging economies. Using a dynamic panel model of loan growth, we investigate the loan granting behavior of 1273 banks in the emerging economies of Asia, Latin America, and Central and Eastern Europe during the period from 1996 to 2003. Applying the pooled OLS, system GMM, and panel VAR estimators, we find consistent evidence that foreign banks are less responsive to monetary shocks in host countries, as they adjust their outstanding loan portfolios and interest rates to a lesser extent than domestic private banks, independent of their liquidity, capitalization, size, efficiency, and credit risk, and although there exists a bank lending channel in the emerging economies, it is declining in strength due to the increased level of foreign bank penetration. We also explore possible driving factors for the different responses of foreign and domestic banks to monetary policy shocks by investigating foreign banks’ different behavior during banking crises and tranquil periods, the effects of mode of entry to host countries, the home-country effects, and the response of foreign banks from OECD countries vs. all foreign countries including non-OECD countries. We suggest the access of foreign banks to funding from parent banks through internal capital markets as the most convincing explanation.     

Multinational Banks and the Global Financial Crisis: Weathering the Perfect Storm?

We use data on the 48 largest multinational banking groups to compare the lending of their 199 foreign subsidiaries during the Great Recession with lending by a benchmark of 202 domestic banks. Contrary to earlier and more contained crises, parent banks were not a significant source of strength to their subsidiaries during 2008–09. When controlling for other bank characteristics, multinational bank subsidiaries had to slow down credit growth almost three times as fast as domestic banks. This was in particular the case for subsidiaries of banking groups that relied more on wholesale funding.     

International Banking and Liquidity Allocation

This paper explores the comparative advantage of multinational banking over cross-border financial services in terms of capitalizing on a global access to funding sources. We argue that this advantage depends on the benefit and the cost of multinational banks’ intimacy with local markets. The benefit is that it allows multinational banks to create more liquidity. The cost is that it causes inefficiencies in internal capital markets, on which a bank relies to allocate liquidity across countries. We analyze the conditions under which multinational banking is then likely to arise and show that capital requirements have an effect as they influence the degree of inefficiency in internal capital markets for alternative organization structures differently.     

Capital Constraints,Asymmetric Information,and Internal Capital Markets in Banking: New Evidence

A growing literature investigates the role of internal capital markets in mitigating financial constraints faced by the subsidiaries of a conglomerate. Most studies have relied on indirect tests based on correlations between the cash flows and the investment of the subsidiaries. In contrast, we avoid the widespread criticisms of such specifications by providing direct tests that focus on the mechanisms through which internal reallocations of funds occur. We find that internal capital markets are used by multibank holding companies to mitigate capital constraints faced by individual bank subsidiaries. In addition, we show that internal capital management within a multibank holding company involves not only the movement of capital to those subsidiaries with a relatively greater need for capital but also the movement of assets (loans) from less well capitalized to better capitalized subsidiaries by means of loan sales and purchases among the subsidiaries. Furthermore, net loan sales are used to allow efficiency‐enhancing specialization among bank subsidiaries, insofar as those subsidiaries with the best loan origination opportunities are able to focus on loan originations even if they do not have sufficient capital to hold the loans. Our evidence is consistent with banks affiliated with holding companies more actively participating in loan sales and purchases because, by using their internal secondary loan market, they are able to avoid the “lemons” problem faced by stand‐alone banks.     

Firm balance sheets and monetary policy transmission

The functioning of internal capital markets in financial conglomerates facilitates a novel identification strategy of the balance sheet channel of monetary policy. We look at small subsidiary banks that are affiliated with the same holding company but operate in different geographical areas. These banks face the same marginal cost of funds due to internal capital markets, but face different borrowers as they concentrate their lending with small local businesses. Exploring cross-sectional variation in local economic conditions across these subsidiaries, we investigate whether borrower creditworthiness influences the response of bank lending to monetary policy. Our results are consistent with a demand-driven transmission mechanism that works through firm balance sheets and is independent from the bank lending channel.     

Foreign bank subsidiaries' default risk during the global crisis: What factors help insulate affiliates from their parents?

This paper examines the association between the default risk of foreign bank subsidiaries in developing countries and their parents during the global financial crisis, with the purpose of determining the size and sign of this correlation and, more importantly, understanding what factors can help insulate affiliates from their parents. We find evidence of a significant and robust positive correlation between parent banks’ and foreign subsidiaries’ default risk. This correlation is lower for subsidiaries that have a higher share of retail deposit funding and that are more independently managed from their parents. Host country bank regulations are also associated with the extent to which shocks to the parents affect the subsidiaries’ default risk. In particular, the correlation between the default risk of subsidiaries and their parents is lower for subsidiaries operating in countries that impose higher capital, reserve, provisioning, and disclosure requirements, and tougher restrictions on bank activities.     

Banking Globalization and Monetary Transmission

Globalization of banking raises questions about banks’ liquidity management, their response to liquidity shocks, and the potential for international shock propagation. We conjecture that global banks manage liquidity on a global scale, actively using cross‐border internal funding in response to local shocks. Having global operations insulates banks from changes in monetary policy, while banks without global operations are more affected by monetary policy than previously found. We provide direct evidence that internal capital markets are active in global banks and contribute to the international propagation of shocks. This feature was at play during the financial crisis of 2007–2009.     

Credit growth in Central,Eastern, and South-Eastern Europe: The case of foreign bank subsidiaries

In this paper, we investigate the credit growth of foreign-owned banks in Central, Eastern, and South-Eastern Europe from 2000 to 2014. We intend to show whether foreign capital in the banking sector should be treated as a monolith, as it currently is in the literature. To this end, we analyse credit growth based on the status of the parent company (global systemically important banks, or G-SIBs, vs. non-GSIBs) and European Union membership of the countries of the subsidiaries. The analyses are carried out on a panel of banks with the use of the panel corrected standard error methodology. Additionally, we differentiate between the pre-crisis and crisis/post-crisis periods to identify whether the policy of parents changed after the outbreak of the crisis. We find important differences in the determinants of the credit growth of subsidiaries, indicating that foreign capital in the banking sector should not be treated as a monolith.     

Determinants of the capital adequacy ratio of foreign banks’ subsidiaries: The role of interbank market and regulation

This paper examines the factors influencing the capital adequacy ratio (CAR) of foreign banks. We test whether the CAR of subsidiaries and branches in developed and developing countries depends on the same factors. We use data from 310 subsidiaries and 265 branches to test the impact of the parent banks’ fundamentals on subsidiaries’ and branches’ capital ratios. We also study how the economic condition and regulatory environment in a bank's home country determine foreign banks’ CAR. Our results provide strong evidence that the CAR of subsidiaries and branches operating in developing and developed countries do not depend on the same set of explanatory factors. We also find that the regulatory framework of a parent bank's home country affects the capitalization of its foreign subsidiaries in the host countries. Finally, we show that specific variables of the parent bank have a stronger effect for foreign banks highly related to the interbank market.     

Foreign banks in syndicated loan markets

Foreign banks play a prominent role in syndicated loan markets. In this paper we examine foreign banks’ motives in participating in cross-border deals in 25 European countries. We find that usual explanations of foreign banking activities can only account partly for the high rate of foreign involvement in syndicated loan markets. The usual argument is that foreign banks are at a disadvantage because they lack soft information and thus they tend to lend to more transparent firms compared to their domestic counterparts. We find that this relationship only holds in relatively small financial systems. We illustrate different motivations for the large amount of cross border lending in large developed markets. In these markets foreign banks tend to lend to especially risky borrowers and projects.     

The effect of banking crisis on bank-dependent borrowers

We provide causal evidence that adverse capital shocks to banks affect their borrowers’ performance negatively. We use an exogenous shock to the U.S. banking system during the Russian crisis of Fall 1998 to separate the effect of borrowers’ demand of credit from the supply of credit by the banks. Firms that primarily relied on banks for capital suffered larger valuation losses during this period and subsequently experienced a higher decline in their capital expenditure and profitability as compared to firms that had access to the public-debt market. Consistent with an adverse shock to the supply of credit, crisis-affected banks decreased the quantity of their lending and increased loan interest rates in the post-crisis period significantly more than the unaffected banks. Our results suggest that the global integration of the financial sector can contribute to the propagation of financial shocks from one economy to another through the banking channel.     

Market discipline during crisis: Evidence from bank depositors in transition countries

The Central European banking industry is dominated by foreign-owned banks. During the recent crisis, for the first time since the transition, foreign parent companies were frequently in a worse financial condition than their subsidiaries. This situation created a unique opportunity to study new aspects of market discipline exercised by non-financial depositors. Using a comprehensive data set, we find that the recent crisis did not change the sensitivity of deposit growth rates to accounting risk measures. We establish that depositors’ actions were more strongly influenced by negative press rumors concerning parent companies than by fundamentals. The impact of rumors was especially perceptible when rumors turned out ex post to be founded. Additionally, we document that public aid announcements were primarily interpreted by depositors as confirmation of a parent company’s financial distress. Our results indicate that depositors react rationally to sources of information other than financial statements; this discovery has policy implications, as depositor discipline is usually the only viable and universal source of market discipline for banks in emerging economies.     

How banks go abroad: Branches or subsidiaries?

We examine the factors influencing international banks’ organizational form, using an original database on the operations in Latin America and Eastern Europe of the world’s top 100 banks. We find that banks are more likely to operate as branches in countries that have higher taxes and lower regulatory restrictions on bank entry and on foreign branches. Subsidiary operations are preferred by banks seeking to penetrate host markets by establishing large retail operations. Finally, economic and political risks have opposite effects, suggesting that legal differences in parent banks’ responsibilities associated with branches and subsidiaries are important determinants of banks’ organizational form.     

Financial Exposure and the International Transmission of Financial Shocks

This paper analyzes the transmission mechanism of banking sector shocks in an international real business cycle model with heterogeneous bank sizes. We examine to what extent the financial exposure of the banking sector affects the transmission of foreign banking sector shocks. In our model, the more exposed domestic banks are to the foreign economy via lending to foreign firms, the greater are the spillovers from foreign financial shocks to the home economy. The model highlights the role of openness to trade and the dynamics of the terms of trade in the international transmission mechanism of banking sector shocks: spillovers from foreign banking sector shocks are greater the more open the home economy is to trade and the less the terms of trade respond to foreign shocks.     

Do foreign banks increase competition? Evidence from emerging Asian and Latin American banking markets

In this paper we examine the impact of foreign bank penetration on the competitive structure of domestic banking sectors in host emerging economies. We focus our analysis on Asia and Latin America during the period 1997-2008. Using bank-level panel data to identify foreign banks and to estimate measures of banking competition, we are able to provide robust empirical evidence that an increase in foreign bank penetration enhances competition in these host countries’ banking sectors. We find that this positive foreign bank penetration and banking competition link is associated with a spillover effect from foreign banks to their domestic counterparts. This spillover effect becomes stronger when more efficient and less risky foreign banks enter into less concentrated host country markets. We also find that the spillover effect is greater when foreign banks enter in the form of ‘de novo penetration’ than through mergers or acquisitions of domestic banks (‘M&A penetration’).     

Global Banks and Synthetic Funding: The Benefits of Foreign Relatives

This paper examines the effect of dislocations in foreign currency (FX) swap markets (“CIP deviations”) on bank lending. Using data from UK banks we show that when the cost of obtaining swap-based funds in a particular foreign currency increases, banks reduce the supply of cross-border credit in that currency. This effect is increasing in the degree of banks' reliance on swap-based FX funding. Access to foreign relatives matters as banks employ internal capital markets to shield their cross-border FX lending supply from the described channel. Partial substitution occurs from banks outside the UK not affected by changes in synthetic funding costs.     

Organizational mode choices of multinational banks abroad

We investigate the determinants of organizational modes adopted by multinational banks abroad using a unique database of 98 parent banks and their organizational modes in 169 countries from 2005 to 2015. Our findings reveal that multinational banks operate in various organizational modes abroad, including multiple modes in a single host country; however, subsidiaries are the dominant mode of operation, followed by branches and simultaneously operating branches and subsidiaries in the host country. Furthermore, the characteristics of multinational banks play a significant role in determining their organizational decisions in a host country. Our results indicate that less profitable banks are less likely to open representative offices and are more likely to have branches. In contrast, multinational banks with high asset growth are more likely to operate a representative office abroad and less likely to open a subsidiary. These findings suggest that parent bank profitability and asset growth are important considerations when determining the optimal organizational mode of foreign expansion. Furthermore, country characteristics (particularly openness to economic and capital flows, institutional framework, and geographical and cultural distance) between host and home countries also influence foreign bank operations in a given host country.