19 January 2012

World Bank: Is the financial safety net a barrier to cross-border banking?

This paper provides evidence that internationalised banks face higher interest expenses. In particular, consolidated banks with a higher share of foreign liabilities and a lower international concentration of their liabilities pay higher interest expenses. Benchmark estimation suggests that an international bank’s cost of funds raised through a foreign subsidiary is between 1.5 per cent and 2.4 per cent higher than the cost of funds for a purely domestic bank, which is a sizeable difference given an overall mean cost of funds of 3.3 per cent in this sample. Its finding that internationalised banks face higher interest expenses is robust to IV estimation where indices of country-level economic integration are used to instrument for bank-level internationalisation. Evidence was found that bank internationalisation is associated with higher interest expenses of the unconsolidated parent bank as well, and with lower deposit growth rates of the consolidated bank.

These results suggest that the bank liability holders of internationalised banks expect to suffer relatively high losses on their holdings. Bank liability holders only suffer losses following bank distress if they are not made whole by the financial safety net. Hence, bank liability holders of internationalised banks appear to rely relatively little on the financial safety net. This could reflect that national financial safety net managers are less likely to contribute to the bailout of a cross-border bank, or that the recovery and resolution process as applied to a cross-border bank is expected to be relatively inefficient.

A less reliable financial safety net for international banks puts international banks at a competitive disadvantage, and is a barrier to international banking market integration.

Less ambiguously, the international economy can benefit from enlarging the recovery and resolution options available to authorities dealing with weakened international banks (as envisaged by the European Commission, 2011). In the end, quick intervention strategies and least-cost resolution methods should be made applicable to all banks, regardless of their degree of internationalisation. This would reduce moral hazard and the likelihood of a costly bailout for domestic and cross-border banks alike, thereby creating a level playing field for all banks.

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