31 January 2012

VoxEU: Foreign banks and the global financial crisis - Investment and lending behaviour

This column uses a comprehensive database to show that the crisis dramatically halted foreign direct investment in banking and that foreign banks often cut back on lending more than their domestic competitors. While exits have so far been limited, this is likely to change in the coming years.

Investment and disinvestment during the financial crisis

Foreign bank entries and exits from 1995 to 2009: In the years leading up to the crisis entry peaked, but with the start of the global financial crisis it slowed down markedly. While 2008 still saw entries at levels similar to 2005, in 2009 the number of entries was the lowest since the beginning of the period. This drop in entry is due to a combination of bank-specific and home- and host-country factors. While the crisis affected new entry, until 2009 it hardly had an impact on exits which remained at levels similar to earlier periods. Parent banks, apparently, did not (yet) feel the need to close or sell their foreign affiliates. With the pressure on to increase their capital ratios and with equity markets discounting banks, for many banks selling assets has become a cheaper way to raise capital than selling new stock.

Lending during a financial crisis

The role of foreign banks in financial stability has been much debated, with studies finding ambiguous results. Since the crisis, more studies have pointed out the risks of foreign banking. Indeed, De Haas et al (2011) and Popov and Udell (2010) find for emerging European countries that foreign subsidiaries reduced their lending more compared to domestic banks. In a recent Vox column, De Haas and van Lelyveld (2011) report similar results when comparing loan growth of foreign subsidiaries of large multinational banking groups with large domestic banks. Other recent studies also have found that foreign banks created financial instability in their host countries during the crisis.

New results suggest the role of foreign banks differs by circumstances

The impact of the crisis on foreign relative to domestic bank lending does, however, crucially depend on a number of host-country and bank characteristics.

• First, foreign banks in OECD countries already in 2008 reported lower loan growth compared to domestic banks.
• Second, while in countries with minority presence foreign banks reduced domestic credit during 2009 more than domestic banks did, the opposite is the case in countries dominated (in terms of numbers) by foreign banks.
• Third, having access to deposit funding during the crisis turns out to be especially important for foreign banks to maintain credit.

Future prospects

The crisis continues to affect global banking systems in many ways. Faced with large losses and capital shortfalls, many banks in advanced countries are undergoing major restructurings, either voluntary or as conditions of government support. Furthermore, banks need to comply with stricter regulations, such as Basel III and other measures triggered by the crisis. And all banks are responding to changing global economic patterns, including the economic slowdown in advanced countries and the increased economic importance of emerging markets.

Given these developments, the past patterns documented suggest some possible future paths. While many advanced country banks are less likely to be active investors in the near future, banks from emerging markets, being in much better financial positions, are likely to step into the void, increasing their relative importance as foreign investors, especially within their geographical regions. As such, the foreign-bank landscape is likely to change substantially in the future.

Full article

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