Bang Nam Jeon, María Pía Olivero, Ji Wu Matěj Melichar Robert Havelka Farid Bakhshaliyev

 Presence of foreign banks has increased rapidly in developing and emerging economies in recent years  Foreign banks contribute to enhancing the efficiency, competitiveness, and stability of the banking systems in host economies  On the other hand – destabilizing force  Short-term profit seeking, home biasedness, and source of contagion during banking crisis  This paper studies the role of internal capital markets as a channel of transmission of financial shocks across countries.

Gr(loans) – Growth rate of loans of subsidiary Subfund – Measure of funds generated by subsidiary Subchar- Subsidiary specific (liquidity, size, riskiness) Hostmacro – Vector of host country macroeconomic conditions Parfund – Measure of funds generated by parent bank Parchar - Financial characteristics of the parent bank Homemacro - Macroeconomic variables in the home country

 Bank-level data for the major multinational parent banks from industrial countries and their foreign subsidiaries operating in emerging and developing countries during the period 1994–2008  368 subsidiaries of 68 multinational banks from 25 home countries  Foreign subsidiary - incorporated in the host country and at least 50% of its voting stocks are owned by a foreign parent bank.  Estimated using difference GMM, system GMM and FGLS correcting for first order autocorrelation

 Investigating the effect of internal capital markets in multinational banking on lending of foreign subsidiaires => transmission channel of financial shocks from the parent bank to a foreign subsidiary  subsidiaries‘ own internally generated funds => important for their lending (1% increase in funds => 0.67% increase in lending) and suggests external finance is costly  However, internally generated funds of parent banks are the most important determinant of subsidiaries‘ lending  liquidity and capitalization of parent banks is not found to be important  when enough of funds from the parent bank => subsidiaries depend less on their own funds and more on the parent bank => internal capital market is very important

 Does the internal capital market work both ways? Do parent banks also stop supporting (or even suck money from) its subsidiaries, when their own situation worsens?  Parent bank might be hit by adverse shock => decreases its support (cash flow) to its subsidiary  Dataset split into „negative income periods“, „low income periods“ and „positive income periods“ depending on the internal funds available for the parent bank  Authors find evidence that internal capital market works both ways => subsidiaries may be left to rely on their own funds, when parent bank is in „low income period“  When „negative income period“ occurs, parent banks drain funds from its subsidiaries

 tranquil means non-crisis  When there is a crisis in home country of the parent bank => does it affect lending of subsidiary through an internal capital market?  Dataset split into two parts => crisis (some systemic banking crisis) and non-crisis years  During non-crisis years => evidence of support of parent banks towards its subsidaries  During crisis years => evidence of much lower support from the parent bank towards a subsidiary, even transfer FROM the subsidiaries to a parent bank is possible in such times

 Does the internal capital markets function differently across regions? Are the shocks transmitted the same way everywhere?  Dataset split by subsidiaries‘ region of origin – Central and Eastern Europe, Asia and Latin America  There is evidence that subsidiaries in different regions are affected differently  Subsidiaries in CEE are affected the most (1% decrease in funds from parent bank => 0.7% increase in dependence of subsidiary on its own funds), subsidaries in other regions are not as much affected  Explanation – subsidiaries in Latin America are funded by predominantly by domestic deposits, similar in Asia  The effect of last financial crisis was not as pronounced in Latin America, as opposed to the effect on CEE and Asia

 Is the spillover from previous part regional or global? Are the affected subsidiaries close to their parent bank or are located far away?  Authors find that the distance between the parent bank and subsidiary is not important for the capital spillovers  The financial support from parent banks is reduced to all of their subsidiaries world-wide

 Is the effect of internal capital markets constant through time or not?  Emerging markets started to be penetrated by international banks beginning in 1980s, however, most important expansion happened during the last decade  Dataset split into – before and after 2001  The effect of internal capital markets DO change with time  The use of internal capital markets grew with time  Subsidiaries in emerging markets – now more dependent on funding from the parent banks than before

 Number of robustness tests performed => results are robust, conclusions do not change

 when there are financial frictions and limited access to alternative funding sources, subsidiaries are unable to sufficiently finance their lending with their own liabilities  the higher the loan-to-deposit ratio and the stronger their liquidity constraints, the more subsidiaries would seek the parent bank’s funds  parent banks tend to allocate more resources to the subsidiaries facing higher liquidity constraints  less independent subsidiaries tend to be more affected by the transmission of financial shocks via internal capital markets

 the entry mode of subsidiaries reflects their degree of integration with the global conglomerate  greenfield subsidiaries are more tightly integrated with the global conglomerate, an have greater access to the internal capital markets  greenfield banks tend to extend more loans in foreign currency  de novo subsidiaries are more closely integrated with their parent banks via internal capital markets than M&A subsidiaries

 the internal capital markets’ attenuating effect on the subsidiaries’ reliance on their own internal funds operates regardless of the level of financial openness in the host countries  subsidiaries’ lending in host countries with higher capital account openness is more deeply associated with their parent banks’ funds  the overall sensitivity of lending by subsidiaries located in host countries with higher capital account openness to their own internal funds is higher as compared with host countries with lower capital account openness

 the transmission of financial shocks through domestic capital markets depends on the concentration of banking on host markets  when expanding to a host market with a lower concentration level, foreign banks may face more intense competition  cash flow-constrained foreign subsidiaries seek greater support from their respective parent banks when the competitive struggle on the host markets is more intense

 Using internal capital markets, multinational banks are able to shift risk and re-allocate revenues between the parent bank and its foreign subsidiaries  Internal capital markets transmit both favorable and adverse shocks by affecting subsidiaries’ reliance on their own internal funds  Mechanism of transmission varies in strength during tranquil periods vs. crisis periods  Strongest among subsidiaries in Central and Eastern Europe, followed by Asia and Latin America; global rather than only regional; and more conspicuous in recent years than before 2001.

Regulators should pay special attention to foreign bank subsidiaries that:  Have higher loans-to-deposits ratio  Are newly established subsidiaries  Are operating in more financially open or in less concentrated host banking markets.