28 February 2022

BIS: Global banks' local presence: a new lens

Branches pose higher risks to host countries than subsidiaries do, because of more volatile asset growth, greater responsiveness to home country conditions, and weaker control by host authorities.

Banks operate internationally through networks of branches and subsidiaries, also known as foreign banking offices (FBOs). Newly collected system- and entity-level data across two dozen host countries confirm stylised facts on these entities' balance sheets and establish new ones. Subsidiaries, which resemble local banks in their focus on domestic currency and retail business, have reduced their share of FBO assets over the past decade, in favour of branches, which are tailored to flexibly provide international services. This shift may raise financial stability concerns, not least because branches' asset growth has been more responsive than subsidiaries' to financial and economic conditions outside host jurisdictions. Judging by the evolution of liquidity and intragroup positions, host supervisors have influenced branches' operations in advanced economies but less so in emerging market ones. ¹

JEL classification: F30, G15, G21.

International banks develop and maintain their customer networks through local offices in several host countries. These foreign banking offices (FBOs) take two forms: subsidiaries and branches. The choice between the two reflects the holding company's global business model. A model focused on corporate and investment banking delivers international services through branches that are largely wholesale-funded and legally part of the parent, thus reporting to the parent's supervisors in the home country. By contrast, a multinational retail bank tends to rely on locally incorporated and supervised subsidiaries that behave much like the domestically headquartered banks of the host country, not least in their reliance on retail funding. The characteristics of each type – the flexibility and responsiveness of branches, and the stable local relationships of subsidiaries – have important implications for the transmission of stress across borders.

This feature contributes to the understanding of global banks' local presence, focusing on structural and behavioural differences between foreign branches and subsidiaries as reflected in their balance sheets. It does so by combining the aggregate perspective of the BIS international banking statistics (IBS) with a novel database that includes standardised, detailed balance sheet histories of FBOs in 24 host jurisdictions from advanced economies (AEs) and emerging market economies (EMEs). We use these data to complement previous analyses of FBOs that relied on either more granular single-country or less specific multi-country data.

Our main contribution is threefold. First, based on the new database, we validate the commonly held view that branches and subsidiaries have distinct balance sheet structures. Previously established for just a handful of individual countries, our confirmation of this stylised fact underscores two points: subsidiaries' balance sheets resemble those of local banks; and branches rely more on fickle wholesale funding and hold relatively large intragroup positions.

Second, we document two new stylised facts. While FBOs' combined share of host country banking assets has been stable over the past decade, this masks two underlying shifts: the gains by FBOs headquartered in EMEs – especially China – at the expense of their AE peers; and the decline of subsidiaries' share in FBO assets, in both AE and EME hosts. In addition, using entity-level information, we show that subsidiaries are less profitable as a group than local peers. This may help explain the reduction in global banks' reliance on subsidiaries.

Finally, we use the new data to confirm and refine previous findings on the higher volatility of branch assets and to study trends in FBO liquidity ratios. Not only are branches' assets and loans more volatile than those of subsidiaries, but they are also particularly responsive to home country financial and economic conditions. It is therefore unsurprising that several host prudential authorities have long expressed a preference for subsidiaries, and a few have actively adopted measures to "ring-fence" branch activities. Using newly constructed liquidity indicators and data on branch intragroup positions, we present evidence that authorities have recently tightened constraints on branches in AE hosts, although less so in EME hosts.

The feature is structured as follows. The first section reviews the relationship between the types of FBO and the corresponding balance sheets. It includes a box with a high-level overview of the new FBO database. The second documents broad patterns regarding the presence of FBOs in host country banking systems. The third refines earlier findings on the volatility of foreign banking offices. The fourth reviews liquidity across FBOs and intragroup funding trends for branches. The final section concludes with policy considerations.

International business models and balance sheet structures

Banks' international business models fall into two stylised types: centralised global and decentralised multinational. These vary by customer and product focus, funding model (eg, wholesale versus retail) and the choice between branches or subsidiaries for local presence in foreign countries (CGFS (2010)).

A centralised global bank caters mainly to financial institutions and multinational corporates with services such as trade finance, treasury management and transaction banking that span currencies and jurisdictions. It funds itself in wholesale markets and holds significant positions in US dollars or other major currencies. It manages capital, credit and liquidity centrally, and operates through a limited number of financial hubs. If a local presence is required, this model favours branch entities. Branches are legally and financially embedded within their parent and are overseen primarily by the parent's home authority. Less encumbered by local rules and oversight, these branches manage credit and funding in a way that caters largely to the parent banks' broader needs. This may include the transfer of liquidity to and from other nodes in the bank's global network. As a flip side to this flexibility, branches are typically excluded from the host country's deposit insurance scheme and therefore have limited access to local retail deposits.

The decentralised multinational model, on the other hand, focuses on local currency credit provision in multiple countries. It relies mainly on local funding in host jurisdictions and operates mainly through locally incorporated and capitalised subsidiaries.² These entities are regulated primarily by local authorities and submit to the oversight of, and restrictions on, the transmission of resources away from the host country. In return, they are granted access to domestic insured deposits (McCauley et al (2010), Cerutti et al (2007), Fiechter et al (2011)).

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