Is the Financial Safety Net a Barrier to Cross-Border Banking? Ata Can Bertay (Tilburg University and World Bank) Asli Demirgüç-Kunt (World Bank) Harry Huizinga (Tilburg University and CEPR) Bank Supervision and Resolution: National and International Challenges Vienna, October 3 – 4, 2011

Motivation Banking becoming more and more international Many banking markets still dominated by domestic banks Issues with financial safety net for international banks and burden sharing in case of a bailout Then, is there market discipline exerted on internationalizing banks?

Outline Introduction – Literature – EU case Data The model and empirical results Conclusion (Further progress)

Literature Cost-benefit of internationalization – Efficiency (Berger et al., 2000) – Diversification (Garcia-Herrero and Vazquez, 2007) – Double taxation (Huizinga, Voget and Wagner, 2011) – Cross-border banking crises and fiscal burden sharing (Freixas, 2003) Market discipline on banks – Depositors through interest rates and deposit withdraws (Park and Peristiani, 1998) – Risk sensitivity reflects strength of market discipline, which depends on financial safety net: Explicit deposit insurance (Demirguc-Kunt and Huizinga, 2004; Martinez Peria and Schmukler, 2001) Size: TBTF or TBTS (Demirguc-Kunt and Huizinga, 2011)

Cross-Border Banking: EU case Significant cross-border banking Deposit insurance and organizational form: – Branch=>Home country regime – Foreign subsidiary=>Host country regime Absence of clear rules on burden sharing to eliminate conflicts of interest Resolution outcomes may not take international externalities into account Not optimal decision in an international perspective

Data International panel – Bankscope – 900 publicly listed banks from 83 countries – period Size of unconsolidated subsidiary relative to size of consolidated parent bank Alternative internationalization measures Weighted by parent’s ownership share

Internationalization measures Foreign liabilities share – Sum of the liabilities of foreign subsidiaries divided by the parent bank’s consolidated liabilities Concentration – Sum of squared shares of parent bank’s liabilities – Includes home country (1 minus share for all the foreign countries) Foreign concentration Internationalization dummy Number of countries

Frequency Foreign Liability Share Frequency Countries Internationalization measures

VariablesObsMeanStd. Dev.MinMax Foreign liabilities share Concentration Foreign concentration International Countries Log of countries Interest expense Deposit growth Lagged equity Lagged liquidity Lagged profit Inflation difference Summary stats

Correlations Interest expense Deposit growth Foreign liabilities share Concentration Foreign concentration InternationalCountries Log of countries Interest expense 1 Deposit growth ***1 Foreign liabilities share 0.123*** Concentration *** ***1 Foreign concentration ***0.183***1 International 0.169*** ***-0.528***-0.271***1 Countries 0.096*** ***-0.500***-0.646***0.678***1 Log of countries 0.140*** ***-0.561***-0.668***0.893***0.915***1

The model Dependent variables: – Interest expense – Deposit growth rates Internationalization and interaction with bank profitability Bank level controls – Size – Overhead – Lagged profits – Short-term funding Country level controls Bank and year fixed effects with robust standard errors

Empirical Results Internationalization – Higher interest expenses – Lower deposit growth rates – Higher sensitivity to the bank performance Internationalization decision can be endogenous – Lagged internationalization – IV estimation International inflation differences

Foreign liabilities proxying internationalization (1)(2)(3)(4)(5)(6)(7)(8) Interest expense Deposit growth Foreign liabilities share 0.023***0.044**0.023**0.038**-0.254**-0.545*** ** (0.008)(0.021)(0.010)(0.015)(0.110)(0.148)(0.167)(0.209) Lagged profit-0.074* * (0.038)(0.042)(0.038)(0.041)(1.111)(1.134)(1.113)(1.145) Lagged profit* Foreign liabilities share *25.981**22.930* (1.078)(0.562)(10.882)(13.842) N R-sq

Alternative measures with interest expense (1)(2)(3)(4)(5)(6)(7)(8)(9)(10) Lagged profit-0.074*-0.953*-0.118*** * * ** (0.038)(0.530)(0.044)(0.325)(0.038)(0.042)(0.038)(0.068)(0.038)(0.041) Concentration-0.011***-0.023*** (0.004)(0.009) Lagged profit*Concentration0.898 (0.546) Foreign concentration (0.003)(0.004) Lagged profit*Foreign concentration0.138 (0.329) International (0.001)(0.002) Lagged profit*International-0.125** (0.050) Countries (0.000) Lagged profit*Countries-0.082** (0.041) Log of countries (0.001) Lagged profit*Log of countries-0.167** (0.071) N R-sq

(1)(2)(3)(4)(5)(6)(7)(8)(9)(10) Lagged profit **2.479** ** (1.110)(6.165)(1.197)(3.461)(1.116)(1.191)(1.114)(1.641)(1.115)(1.175) Concentration0.149*0.333*** (0.086)(0.106) Lagged profit*Concentration ** (6.768) Foreign concentration (0.042)(0.063) Lagged profit*Foreign concentration (4.037) International (0.035)(0.034) Lagged profit*International4.188*** (1.454) Countries ** (0.007) Lagged profit*Countries2.088*** (0.670) Log of countries (0.031)(0.029) Lagged profit*Log of countries4.764*** (1.479) N R-sq Alternative measures with deposit growth

Lagging the foreign liabilities share No restriction Lagged foreign liabilities share < 0.3 No restriction Lagged foreign liabilities share < 0.3 (1)(2)(3)(4)(5)(6)(7)(8) Interest expense Interest Expense Interest expense Deposit Growth Lagged foreign liabilities share 0.059* *** ***-0.408***-0.357**-0.520** (0.034)(0.041)(0.014)(0.015)(0.085)(0.109)(0.141)(0.220) Lagged profit *** **-0.105*** (0.039) (0.038) (0.999)(1.008)(1.001)(1.013) Lagged profit*Lagged foreign liabilities share (1.002)(1.085)(8.554)(10.588) N R-sq

IV estimation Country level measures of internationalization: – Tourism – Investments (FDI flows and Portfolio position) – Trade First stage regressions Exclusion restriction

IV estimation interest expense - 1 No restrictionForeign liabilities share < 0.3 (1)(2)(3)(4)(5)(6) Lagged profit ** (0.031)(0.025)(0.028)(0.023)(0.028)(1.453) Foreign liabilities share ** ** (0.047)(0.077)(0.045)(0.075) Lagged profit* Foreign liabilities share **-6.035* (3.118)(3.090) Concentration ** (0.026)(0.040) Lagged profit*Concentration 2.892** (1.463) N R-sq Excluded instruments F-test Hansen J-test (p-value) Endogeneity test (p-value)

IV estimation interest expense - 2 (1)(2)(3)(4)(5)(6) Lagged profit ** (0.029)(0.028)(0.027)(0.180)(0.028)(0.026) International (0.007)(0.010) Lagged profit*International (0.427) Countries (0.003)(0.004) Lagged profit*Countries-0.320** (0.162) Log of countries * (0.007)(0.010) Lagged profit*Log of countries-0.774* (0.442) N2539 R-sq Excluded instruments F-test Hansen J-test (p-value) Endogeneity test (p-value)

IV estimation deposit growth - 1 No restriction Foreign liabilities share < 0.3 (1)(2)(3)(4)(5)(6) Lagged profit **-5.197***-2.743*-4.558**-2.847** ** (1.403)(1.911)(1.414)(1.788)(1.401)(47.854) Foreign liabilities share ** ** (1.621)(3.225)(1.549)(2.647) Lagged profit* Foreign liabilities share ** ** ( )(85.654) Concentration ** (0.946)(1.676) Lagged profit*Concentration ** (48.831) N R-sq Excluded instruments F-test Hansen J-test (p-value) Endogeneity test (p-value)

IV estimation deposit growth - 2 (1)(2)(3)(4)(5)(6) Lagged profit-2.866** **-8.104*-2.943** (1.395)(2.304)(1.443)(4.184)(1.405)(1.805) International (0.358)(0.366) Lagged profit*International (13.992) Countries (0.069)(0.064) Lagged profit*Countries4.629 (3.128) Log of countries (0.272)(0.266) Lagged profit*Log of countries8.200 (9.871) N1846 R-sq Excluded instruments F-test Hansen J-test (p-value) Endogeneity test (p-value)

International inflation differences No restriction Foreign liabilities share < 0.3 No restriction Foreign liabilities share < 0.3 (1)(2)(3)(4)(5)(6)(7)(8) Foreign liabilities share0.016***0.028***0.018**0.029*** (0.005)(0.007) (0.010) Lagged foreign liabilities share0.016** **0.011 (0.008) Lagged profit-0.070* * ***-0.110***-0.101***-0.105*** (0.038)(0.040)(0.038)(0.041)(0.039)(0.038) Lagged profit*Foreign liabilities share **-0.835* (0.470)(0.485) Inflation difference*Foreign liability share 0.371**0.355**0.425**0.451** (0.149)(0.153)(0.197)(0.191) Lagged profit*Lagged foreign liabilities share 1.383*0.892 (0.743)(0.623) Inflation difference*Lagged foreign liabilities share 0.301*0.368** * (0.155)(0.157)(0.147)(0.145) N R-sq

Conclusion and Discussion Internationalizing banks are subject to heightened market discipline by bank depositors Consistent with less generous financial safety net for bank internationalization Competitive disadvantage due to lower implicit subsidies. Can an international resolution agency be a solution? Internalizing externalities But, is it desirable? Decreasing market discipline on international banks, higher risk taking

Further Thoughts Using cross-sectional variation –Pooled OLS with country FE Controlling for systemic size (Liabilities over GDP) An alternative risk measure: Asset volatility Impact of internationalization on unconsolidated interest expense and deposit growth