The Two Faces of Cross-Border Banking Flows Dennis Reinhardt (Bank - PowerPoint PPT Presentation

The Two Faces of Cross-Border Banking Flows Dennis Reinhardt (Bank of England) and Steven J. Riddiough (Warwick Business School) IMF/DNB conference on International Banking: Microfoundations and Macroeconomic Implications 12-13 June 2014

The views expressed are those of the authors and do not necessarily reflect those of the Bank of England and members of its Monetary and Financial Policy Committees. Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 2 / 38

Reinhardt and Riddiough Cross Border Bank to Bank Funding Losses since Lehman Cumulative changes 2008 Q4 to 2009 Q2 (%) • Wide cross-country dispersion of losses in total bank to bank −40 −20 0 20 40 funding following Lehman’s collapse Japan Australia (A) In per cent of own stock Italy Canada Spain Norway Ireland United States UK Germany Sweden The Two Faces of Cross-Border Banking Flows Switzerland France Luxembourg Denmark Turkey South Korea Austria Introduction Chile India Brazil Netherlands Belgium Cumulative changes 2008 Q4 to 2009 Q2 (%) −40 −30 −20 −10 0 Japan Australia Italy Spain (B) In per cent of GDP Canada Norway India United States Chile Brazil Turkey Germany Korea Sweden Austria Denmark June 2014 France UK Ireland Switzerland Netherlands 3 / 38 Belgium Luxembourg 154

Introduction Why the cross-country heterogeneity? • Why did not all banking systems experience a withdrawal in gross cross-border bank-to-bank funding as global risk increased? • One explanation: composition of banking systems’ external funding • Cross-border bank-to-bank funding can be decomposed into two distinctive forms: 1 Arms-length (interbank) funding that takes place between unrelated banks 2 Related (intragroup) funding that takes place between global parent banks and their foreign affiliates • This paper: Do these two funding types show a different behaviour around fluctuations in global risk? ⇒ Is therefore the mix of banking systems’ funding a key determinant of losses in aggregate funding? Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 4 / 38

Introduction Interbank vs Intragroup Funding • Rich literature on determinants of aggregate cross-border funding between banks. Bruno and Shin (2014) suggest that both intragroup and interbank funding are withdrawn when global risk is high • But some key differences : • Interbank funding could be used as a beneficial source of bank monitoring (Calomiris and Kahn, 1991; Calomiris, 1999) and may alleviate liquidity shocks caused by depositor withdrawals (Goodfriend and King, 1998) • But information asymmetries may be larger for interbank funding than for intragroup funding leading to inefficient withdrawals (Huang and Ratnovski, 2011, Gorton and Metrick, 2012, Brunnermeier, 2009). • Internal capital markets : global parent banks have the power to shift liquidity where it is most needed (Cetorelli and Goldberg, 2012). • Volatile intragroup: European banks recycled US wholesale funds intragroup back to head office in Europe (BIS, 2010; McGuire and von Peter, 2009) Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 5 / 38

Introduction Interbank and Intragroup funding since Lehman 10 Cumulative Change in Funding (Median, %) 0 −10 −20 −30 2008 Q3 2008 Q4 2009 Q1 2009 Q2 2009 Q3 2009 Q4 Intragroup funding Interbank funding Note: Cumulative median (exchange rate adjusted) change in intragroup or interbank funding across 25 advanced and emerging market banking systems in per cent of 2008 Q2 stocks Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 6 / 38

Introduction Contribution 1 Interbank and Intragroup funding show a markedly different behaviour in periods of high and rising global risk • Intragroup funding rises when global risk increases and remains stable during periods of high global risk • Interbank funding is withdrawn with EMEs particularly vulnerable - Economic Significance: The mix of banking system’s interbank and intragroup funding alone can explain up to 45% of the change in aggregate cross-border funding following the collapse of Lehman Brothers. - Data: BIS International Banking Statistics by Nationality to disaggregate banking flows into interbank and intragroup 2 Implications of results for theory? Test of the predictions of Bruno and Shin (2014) for disaggregated (interbank and intragroup) banking flows Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 7 / 38

Introduction Contribution 3 Disaggregating intragroup funding further: • Increased funding to parent banks when global risk is high • No evidence of significantly reduced intragroup funding to foreign affiliates ⇒ Policy makers need to monitor the decomposition of bank funding to avoid a misleading assessment of risks to financial stability ⇒ Debate on financial protectionism has recently focused on intragroup flows/internal capital markets (Goldberg and Gupta, 2013) • Results caution against ringfencing policies that restrict intragroup flows • But : In countries where foreign affiliates dominate intragroup funding, the stability benefits of stable intragroup funding are counteracted by increased intragroup lending to parents. Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 8 / 38

Introduction Outline 1 Literature 2 Data 3 Method and Results 4 Conclusion Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 9 / 38

Literature Outline 1 Literature 2 Data 3 Method and Results 4 Conclusion Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 10 / 38

Literature Literature: Cross-border banking flows • Determinants of aggregate (interbank + intragroup) banking flows • Cetorelli and Goldberg (2011) examine the transmission of liquidity shocks from AEs to EMEs via cross-border and local bank lending • See also: Van Rijckeghem and Weder, 2001, 2003; Cerutti and Claessens, 2013; Herrmann and Mihaljek, 2013; Kleimeier, Sander, and Heuchemer, 2013; Bruno and Shin, 2014; Cerutti, Claessens, and Ratnovski, 2014. • ⇒ We instead test the predictions of Bruno and Shin (2014) for disaggregated banking flows Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 11 / 38

Literature Literature: Intragroup funding • Country- or event-specific evidence • Cetorelli and Goldberg (2012a): U.S. parent banks smooth economic shocks at home by channeling funding from their foreign affiliates • Hoggarth, Hooley, and Korniyenko (2013): Intragroup lending by foreign affiliates resident in the U.K. increased strongly following Northern Rock • Schnabl (2012): global banks maintained intragroup funding to Peruvian affiliates following the Russian financial crisis, but withdrew funding from non-affiliates banks • See also Correa, Sapriza, and Zlate (2011), Aiyar (2011), Cetorelli and Goldberg (2012b) • Cross-country evidence • De Haas and van Lelyveld (2014) find foreign affiliates extended less credit domestically than domestic banks in recent financial crisis suggesting that, unlike in previous crises (their 2010 paper), parent banks were unable to support their foreign affiliates Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 12 / 38

Data Outline 1 Literature 2 Data 3 Method and Results 4 Conclusion Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 13 / 38

Data Data: Banking Flows • BIS Locational Statistics by Nationality • Intragroup funding: Liabilities to ’related foreign offices’ • Interbak funding: Liabilities to ’Other banks’ • Source of funding: rest of the world (i.e no bilateral data) • Nationality dimension. Example: intragroup funding of German-owned banks resident in the UK by their parents or other related offices abroad. • Sample: 25 BIS reporting banking systems that report interbank and intragroup data (19 AEs, 6 EMEs) • 1998 Q1 to 2011 Q4 Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 14 / 38

Data Data: Banking Flows Dependent variable: Per cent change in cross-border interbank or intragroup funding: N F j � i,k,t ∆ L j k =1 i,t = × 100 , (1) N S j � i,k,t − 1 k =1 - F denotes the (exchange rate adjusted) flow of interbank or intragroup funding (i=1,2), reported by the BIS, while S denotes the previous-quarter stock of interbank or intragroup funding. - j = 1 , 2 , .., 25, denotes the 25 BIS reporting countries who provide the BIS with both interbank and intragroup data on their resident banks, and k = 1 , 2 , ..., N , refers to the N countries of ultimate bank origin/nationality which have banking operations in country j . Three dependent variables (example for j=UK): 1 Funding to banks of all nationalities resident in the UK (sum over all k) 2 Funding to UK owned banks resident in the UK (parent banks; k = UK) 3 Funding to non-UK owned banks resident in the UK (foreign affiliate; k � = UK) Reinhardt and Riddiough The Two Faces of Cross-Border Banking Flows June 2014 15 / 38