What Determines the Composition of International Bank Flows? - - PowerPoint PPT Presentation

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

Parent Bank Affiliate

]

Total assets (less other sectors)

intrabank lending local lending cross-border lending to firms interbank lending Banking 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

• ption 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

.02 .04 .06 .08 kernel density overhead costs / total assets 20 40 60 80 Claims=0 Claims>0 Kernel density of overhead costs / total assets

Extensive margin: claims on foreign non-bank private sector

.02 .04 .06 .08 kernel density overhead costs / total assets 20 40 60 80 Claims=0 Claims>0 Kernel density of overhead costs / total assets

Extensive margin: claims on foreign banks

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 RI

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) − RI(z − d) (1) If h(z) = 1

2az2, z = a(R − RI)

Capital market clearing requires that all capital is invested in firms: K a

a

z(a)g(a)da = K (2) Solving for RI delivers: RI = R − 1 a

a ag(a)da

(3) Interbank rate RI 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

d=1

Banks that lend on the interbank market z<d

z=d efficiency a loans z(a) to firms

Banks that borrow on the 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 R1 > R2 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: max

• z12,z22,mode

π2(a2) = R2z22 − 1 a2 h(z22) − RIz22 + RId22

• domestic lending

+ + R1z12 − 1 δ12a2 h(z12) − RIz12 − f X

12

• cross-border lending to U.S. firms
• r

R1z12 − 1 a2 h(z12) − RIz12 − f F

12 + RId12

• lending to U.S. firms through affiliate

where f X

12 < f F 12 and 0 < δ12 < 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:

K1 + K2 = total lending by German banks + total lending by U.S. banks

3 All banks located in a country raise funds from domestic depositors:

d11 = d12 = K1 K1 + K2 × (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

d=1

German banks that lend cross‐ border to U.S. firms

efficiency a

Autarky Open Economy German banks with affiliates in the U.S. Germany U.S.

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

Cross‐border lending and FDI

fF

12

Cross‐border lending, no FDI Cross‐border loans by German banks to U.S. firms FDI, no lending cross‐border Local lending to U.S. firms by foreign affiliates of German banks Cross‐border lending and FDI Fixed cost of FDI fF

12

Cross‐border lending, no FDI Net interbank flows to U.S. banks FDI, no lending cross‐border Intrabank flows from German parent banks to their U.S. affiliates

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

Testing for the effect of entry barriers on sectoral composition of bank flows

German bank level data from Deutsche Bundesbank; 2,000 German banks in year 2005 Evidence that banks engage relatively more in interbank lending relative to non-bank private sector lending in countries with higher barriers to foreign bank entry Effect is economically meaningful: If the U.S. increased the impediments to foreign bank entry to those of Mexico, Canada or Spain, then foreign assets in the non-bank private sector held by German banks would decrease by 1.9 percent; assets in the U.S. banking sector would rise by 9.4 percent

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014

The effect of entry barriers on the intensive margin of lending abroad

(1) (2) (3) VARIABLES lnClaimsBvP lnClaimsBvP lnClaimsBvP Entry: Partially repressed A (1/0)

• 0.677
• 0.642

(0.450) (0.451) Entry: Partially repressed B (1/0) 0.657 0.802* (0.460) (0.446) Entry: Fully repressed (1/0)

• 1.451
• 1.349

(0.940) (0.939) Financial Freedom

• 0.00896*
• 0.00936**

(0.00467) (0.00455) ln(Banking sector overhead costs/TA

• 0.617***
• 0.607***
• 0.625***

(0.232) (0.233) (0.223) lnDistance

• 0.101
• 0.0724
• 0.115

(0.0735) (0.0721) (0.0708) lnGDP

• 0.0264
• 0.0439
• 0.0124

(0.0573) (0.0542) (0.0542) lnGDP per capita 0.266** 0.207 0.263*** (0.126) (0.131) (0.101) Observations 6,055 6,055 6,055 Number of clusters 336 336 336

• Adj. R-squared

0.151 0.149 0.149

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014

BIS data

5 10 15 20 25 1999q2 2000q3 2001q3 2002q3 2003q3 2004q3 2005q3 2006q3 2007q3 2008q3 2009q3 2010q3 2011q3 2012q3 2013q3 Millions unallocated non‐bank private sector public sector banking sector

With liberalization over the past 20 years, increase mostly in non-bank private sector assets Collapse larger in interbank assets than in non-bank private sector assets

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014

Policy Discussion

Result of this paper: barriers to foreign bank operations may move activity onto international interbank markets, which is less stable In 2007-2009 financial crisis, problem was mainly foreign funding, not foreign ownership per se (see e.g. Feyen et al. (2014), Claessens and van Horen (2013), Kamil and Rai (2010)); local/global model appears preferable But important to think about the downsides:

◮ more interbank lending, which may be destabilizing ◮ less efficient allocation of capital ◮ higher cost of financial intermediation ◮ no liquidity risk sharing (see Guembel and Sussman (2014))

If problem is due to foreign funding, which triggers credit booms and busts, then macro-prudential policies/capital controls could be more suitable than discouraging international funding model

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014

Conclusions

Interbank lending and lending to firms can be seen as substitutes Changes in the impediments to foreign bank operations change the composition of bank flows Restrictions on global banking may not make domestic credit less but more resilient to financial shocks More research needed on the reasons why different banking/capital flows respond differentially in times of crisis

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014

Thank you for your attention and comments!

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014

Literature

Implications of foreign bank lending: de Haas and van Horen (2013); Peek and Rosengren (2000); Duewel, Frey and Lipponer (2011); de Haas and van Lelyveld (2010); Ongena, Peydro and van Horen (2013); Popov and Udell (2012); Duewel (2013); Schabl (2012), Reinhardt and Riddiough (2013) International banking models: Fillat, Garetto, and Goetz (2014); De Blas and Russ (2013); Niepmann (2012,2013); Bruno and Shin (2013); Corbae and D’Erasmo (2013a, 2013b) Global banks in macro-models: Kollmann (2013); Oliviero (2012); Kollmann, Enders and Mueller (2011), Jaccard and Smets (2014)

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014

The effect of bank entry barriers on the composition of bank flows

Cross‐border lending and FDI

Fixed cost of FDI fF

12

Cross‐border lending, no FDI Cross‐border loans by German banks to U.S. firms FDI, no lending cross‐border Local lending to U.S. firms by foreign affiliates of German banks

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014

The effect of bank entry barriers on the composition of bank flows

Cross‐border lending and FDI

Fixed cost of FDI fF

12

Cross‐border lending, no FDI Net interbank flows to U.S. banks FDI, no lending cross‐border Intrabank flows from German parent banks to their U.S. affiliates

Friederike Niepmann (NY Fed) Composition of International Bank Flows June 13, 2014