What Determines the Composition of International Bank Flows? Cornelia Kerl and Friederike Niepmann Deutsche Bundesbank and Federal Reserve Bank of New York IMF/DNB Conference on “International Banking: Microfoundations and Macroeconomic Implications” June 12-13, 2013 The views expressed in this presentation are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York, the Federal Reserve System, Deutsche Bundesbank or its staff. Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Composition of international bank flows: asset side interbank lending ] Banking Total assets Parent intrabank local Affiliate (less other Bank lending lending sectors) Firms cross-border lending to firms home country host country Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
“Stability Pecking Order” Local lending by banks more stable than cross-border lending (Milesi-Feretti and Tille (2011), Cetorelli and Goldberg (2011), de Haas and van Horen (2013)) Interbank lending less stable than intra-bank lending (Schnabl (2012), Reinhardt and Riddiough (2013), McCauley, McGuire and von Peter (2012)) In response to increase in capital requirements, banks reduce international interbank lending more than cross-border lending to firms (Aiyar, Calomiris, Hooley, Korniyenko, and Wieladek (2013)) ⇒ Composition of bank flows matters for transmission of shocks ⇒ International interbank lending appears to be the least stable form of international bank flows Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
What determines the composition of bank flows? This paper provides a model to explain the composition of international bank flows building on Niepmann (2012, 2013) Key result: when the impediments to foreign bank operations increase, the reliance of domestic banks on foreign interbank loans increases ⇒ Lending to foreign firms and lending to foreign banks are substitutes Data support this idea and suggest that bank entry barriers impede private sector lending more than interbank lending So impediments to foreign bank operations may move activity onto international interbank markets, which are less stable In addition, cost of financial services and efficiency of capital allocation worsens when foreign banks are not allowed to enter ⇒ Global banks with their internal capital markets may be a better option than the reliance of domestic banks on foreign bank funding Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Facts on Structure of International Bank Activities Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Composition of foreign positions of German banks Foreign assets share in for. ass thereof in affil. Claims on banks 0.274 0.462 Claims on non-bank privates 0.376 0.700 Foreign liabilities share in for. liab. thereof in affil. Liabilities in banks 0.557 0.458 Liabilities in non-bank privates 0.328 0.574 Net positions in EUR billion Net claims on banks -302.396 Net claims on non-bank privates 355.423 Net foreign assets 718.968 Interbank lending and non-bank private sector lending and borrowing are all important components Foreign affiliates mainly engage in private sector activities Germany is a net borrower from other banks and a net lender to the foreign non-bank private sector Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Structure of the (international) interbank market Small banks borrow from large banks on interbank market (Craig and von Peter (2014), Stigum (1990)) Only the more efficient banks lend to foreign non-banking firms Extensive margin: claims on foreign non-bank private sector Extensive margin: claims on foreign banks Kernel density of overhead costs / total assets Kernel density of overhead costs / total assets .08 .08 kernel density overhead costs / total assets kernel density overhead costs / total assets .06 .06 .04 .04 .02 .02 0 0 0 20 40 60 80 0 20 40 60 80 Claims=0 Claims>0 Claims=0 Claims>0 Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
The Closed Economy Model Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Setup Mass of bankers K , each endowed with one unit of deposits Banks give out loans to firms for return R per unit invested Banks need to monitor firms at a cost c which is convex in the volume of loans Banks are heterogeneous with respect to monitoring cost; draw efficiency parameter a from distribution g ( a ) Banks can borrow and lend without costs on the interbank market at endogenous rate R I Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Banks’ profits Profits of banker with efficiency a : π ( a ) = Rz − 1 ah ( z ) − R I ( z − d ) (1) If h ( z ) = 1 2 a z 2 , z = a ( R − R I ) Capital market clearing requires that all capital is invested in firms: � a K z ( a ) g ( a ) da = K (2) a Solving for R I delivers: 1 R I = R − (3) � a a ag ( a ) da Interbank rate R I clears the market so that all funds are lent to firms Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
A bank’s loans to firms as a function of its efficiency a loans z(a) to firms d=1 efficiency a z=d Banks that lend on the interbank Banks that borrow on the market z<d interbank market z>d Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
The Open Economy Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Setup Two countries (1 and 2) with R 1 > R 2 and similar banking sector efficiencies Let’s call country 1 the U.S. and country 2 Germany Banks can: ◮ lend to and borrow from each other on the interbank market without costs ◮ extend loans cross-border to foreign firms for a fixed cost f X ◮ establish foreign affiliates for a fixed cost f F > f X , which eliminates information frictions and allows banks to raise deposits abroad Love for variety in loans/diversification motive For simplicity, only German bank lend to foreign non-banking firms Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Bank profits Profits of German bank: R 2 z 22 − 1 h ( z 22 ) − R I z 22 + R I d 22 max π 2 ( a 2 ) = + a 2 ���� z 12 , z 22 , mode � �� � domestic lending 1 h ( z 12 ) − R I z 12 − f X + R 1 z 12 − 12 δ 12 a 2 � �� � cross-border lending to U.S. firms R 1 z 12 − 1 h ( z 12 ) − R I z 12 − f F 12 + R I d 12 or a 2 � �� � lending to U.S. firms through affiliate where f X 12 < f F 12 and 0 < δ 12 < 1 Sorting of banks into foreign activities: the most efficient banks establish foreign affiliates; banks with intermediate efficiency lend cross-border to firms; the least efficient banks operate only at home Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Equilibrium conditions 1 All banks optimally decide how much to lend at home and how much to lend abroad and on the mode (cross-border versus through affiliate) 2 Interbank market clears, i.e. the entire capital in the global economy is invested in firms: K 1 + K 2 = total lending by German banks + total lending by U.S. banks 3 All banks located in a country raise funds from domestic depositors: K 1 d 11 = d 12 = K 1 + K 2 × (mass of German banks with affiliates in U.S.) Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Open economy versus autarky Autarky Open Economy U.S. d=1 Germany efficiency a German banks with affiliates German banks that lend cross ‐ in the U.S. border to U.S. firms More capital allocated to high return country Banks with lower monitoring costs expand and become larger Aggregate intermediation costs go down Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Bank entry barriers and the composition of bank flows Local lending to U.S. firms by foreign affiliates of German banks Intrabank flows from German parent Cross ‐ border loans banks to their U.S. affiliates by German banks to U.S. firms Net interbank flows to U.S. banks 0 0 f F 12 Fixed cost of FDI f F 12 FDI, no lending Cross ‐ border lending and FDI Cross ‐ border FDI, no lending Cross ‐ border lending and FDI Cross ‐ border cross ‐ border lending, no FDI cross ‐ border lending, no FDI When entry barriers increase, intrabank lending and foreign private sector lending go down, interbank lending goes up Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
Additional Empirical Results Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014
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