0 Jordan Fabyanske Harvard Kennedy School July 14, 2015 EIB-B220: Global Financial Services Not Such a “Small World” After All The Great Recession and the Evolving Network of Cross-Border Bank Exposure

1 AGENDA  Network basics  Historical context  Recent trends  Findings and implications  Key takeaways

2 LenderBorrower Exposure Network Basics (1 of 3)

3 Borrower Exposure Network Basics (2 of 3) Lender More Exposure Less Exposure

4 Borrower Exposure Network Basics (3 of 3) Lender Diversified ExposureConcentrated Debt (Exposure Provision)

5 A 2007 BoJ study was the first to look at the cross-border bank exposure network Sorted by Income-per-capitaSorted by Data Availability Cross-Border Bank Exposure Network (Dec. 2006) Source: Bank of International Settlements; Masazumi Hattori and Yuko Suda (Bank of Japan Working Paper Series), 2007 Developed CountriesReporting Countries Less Developed Countries Non-Reporting Countries

6 The bank exposure has become more connected, despite financial crises Historical Evolution of the Cross-Border Bank Exposure Network ( ) Note: (*) The cross-border bank exposure network is “directed”; out-degree refers to the counterparties to which a country is exposed Source: Bank of International Settlements; Masazumi Hattori and Yuko Suda (Bank of Japan Working Paper Series), 2007 Average Path LengthAverage Out-Degree (*)

7 Since ‘06, the Great Recession has altered the path of the global financial system Recent Evolution of the Cross-Border Bank Exposure Network (Dec Sep. 2009) Sep Mar Sep Mar Sep Mar Source: Bank of International Settlements; author’s analysis Sep Sep Sep Mar Mar Mar Bear Stearns Collapse Lehman Brothers Collapse Bear Stearns Collapse Lehman Brothers Collapse Average Path LengthAverage Out-Degree

8 Exposure provisions are more concentrated than before HHI <0.10 Histogram of Exposure Concentration (*) (In # of countries per Hirfindahl-Hirschman Index, Sep Sep. 2009) Sep Sep Sep Average HHI Banks have collapsed their portfolios of cross-border exposures Note: Refers to exposures directed to each country; The higher a country’s HHI, the fewer countries playing an key role in exposure provision to that country Source: Bank of International Settlements; author’s analysis “Yield-seeking” behavior + Higher cost of financing

9 The largest increases in liability concentration have been among LDCs Azerbaijan Colombia El Salvador Egypt Oman Armenia Benin British Overseas Territories Bangladesh US Pacific Islands Germany Largest Increases in HHI Among Low HHI Countries (*) (change in HHI vs. initial HHI value, Sep Sep. 2009) Note: (*) “Low HHI countries” refers to countries whose debt stems from a relatively large number of countries, i.e., HHI < Source: Bank of International Settlements; author’s analysis Hirfindahl-Hirschman Index (HHI) for Debt Concentration in Sep Change in HHI, Sep Sep Fewer lenders are exposed to LDCs What’s going on with Germany?

10 Germany’s increase in liability concentration is mainly due to greater exposure from some, and less exposure from others France United States Japan Sweden Belgium United Kingdom Italy Switzerland Ireland Austria Spain Netherlands Change in Exposure to Germany by Major Lending Country (*) (in US$ billions, ) Note: (*) “Major Lending Country” refers to countries whose total exposure to Germany is greater than $50 billion in 2007 Source: Bank of International Settlements; author’s analysis Total Exposure in 2007 (in US$ bn.)

11 To see the actual network, we can look at the top 10% of links by exposure without losing too much information Fraction of Total Links vs. Exposure Threshold (Dec. 2006) Source: Bank of International Settlements; author’s analysis Exposure Threshold in US$ millions (log scale) Note: thresholds below 10 3 fail to capture many exposures as most less developed countries do not report to BIS. Visualization of exposures in excess of $50 billion allows for greater ease of network interpretation In % of Total Links

12 Mar Legend Reporting Non-Reporting High Exposure Low Exposure Size Denotes Total Liabilities Source’s Assets Target’s Liabilities

13 Mar Legend Reporting Non-Reporting High Exposure Low Exposure Y-o-y Increase Y-o-y Decrease Size Denotes Total Liabilities Source’s Assets Target’s Liabilities

14 Mar Legend Reporting Non-Reporting High Exposure Low Exposure Y-o-y Increase Y-o-y Decrease Size Denotes Total Liabilities Source’s Assets Target’s Liabilities

15 In the wake of The Great Recession, outstanding exposures trended away from LDCs and toward established lender-borrower relationships Mar Mar.2009Sep.2007Mar.2008Sep Comparison of Selected Exposures (Mar Mar. 2009) Source: Bank of International Settlements; author’s analysis Japan to U.S. U.K. to U.S. Sweden to Finland Spain to Mexico Germany to Switzerland Germany to Austria Portugal to Brazil Australia to New Zealand In Ratio to Base Year Value (= 100) (1) All Developed Countries to All Developing Countries (2) All Selected Exposures Between “Similar” Countries ILLUSTRATIVE (1) Average Quarter-on-Quarter Growth (2) Average Quarter-on-Quarter Growth 9.6% 3.4% -1.2% 0.0% Selected Exposures Between “Similar” Countries

16 KEY TAKEAWAYS  This crisis is different  Financial markets are less fragile, but less efficient  “Yield-seeking” is a key driver of globalization in banking  Historical lender-borrower relationships matter