The EU’s banking sector is not only the largest in the world, but also accounts for the bulk of the “financial de-globalisation” observed in cross-border banking since the global financial crisis. In this paper authors provide an anatomy of the great cross-border banking retrenchment in the EU and investigate a wide range of possible drivers of this phenomenon, including indicators of banking sector performance and stability, prudential policies and bank levies. Using a granular breakdown of cross-border bank lending by instrument and counterparty sector, they are able to identify the most affected components of cross-border lending and shed light on the underlying causes.
Banks located in the euro area and in the rest of the EU reduced their cross-border bank claims by around 25% since the global financial crisis, driven by a sharp and sustained reduction in intra-EU claims, which make up 60% of total EU cross-border claims. Within the EU, banks have cut their cross-border loans by around 40% which particularly affected cross-border interbank lending. Their empirical analysis shows a significant link between deteriorating asset quality and the great retrenchment in cross-border banking, highlighting the spillovers from national banking sector conditions across the EU. Authors also find evidence that prudential policies can entail spillovers via cross-border banking in the EU, albeit with heterogeneity across instruments in terms of direction, magnitude and significance. In particular, their results suggest that regulatory arbitrage might be possible via the use of foreign branches, while stricter policies at home may preclude banks from direct lending activities abroad, even though this does not apply within the euro area. For newly introduced bank levies, authors do not find a discernible link to the great retrenchment, but they may have affected the composition of cross-border banking by incentivising lending to the non-bank sector.
Their analysis suggests that tackling the persistent asset quality problems in the EU is pivotal in order to reap the potential benefits of cross-border banking which relate for instance to risk diversification and risk-sharing. Hence, the findings of this paper make a case for completing the banking union. For instance, the rulebook for financial actors in the EU needs to be amended by adding a chapter on a harmonised approach to the resolution of non-performing loans (NPLs), complemented by countryspecific elements in each high-NPL constituency, as stressed by Constâncio (2017).
Working paper
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