Foreign banks and financial stability in emerging markets - evidence from the global financial crisis © F r a n k f u r t – S c h o o l. d e 17th Dubrovnik Economic Conference June 30th 2011 Ursula Vogel Adalbert Winkler

© F r a n k f u r t – S c h o o l. d e 2 Motivation Stability benefits and challenges of foreign banks Data and empirical model Results Conclusions Outline

© F r a n k f u r t – S c h o o l. d e 3 EME crises of the 1990s reflect weak domestic banking sectors Foreign bank entry seen as a key instrument to strengthen EME banking sectors and reduce risk of sudden stop / reversal of capital flows (Sachs/Woo 1999, Mishkin 2001/2006) Different degree of institutional integration across world regions Motivation

© F r a n k f u r t – S c h o o l. d e 4 Average foreign bank asset share per region

© F r a n k f u r t – S c h o o l. d e 5 Cross-border bank flows to EMEs

© F r a n k f u r t – S c h o o l. d e 6 Quarterly changes in domestic lending in EMEs

© F r a n k f u r t – S c h o o l. d e 7 Did foreign bank presence have an impact on financial stability in emerging markets during the crisis? Did foreign banks stabilize cross-border bank flows and domestic lending? Research questions

© F r a n k f u r t – S c h o o l. d e 8 Foreign bank presence strengthens EME banking sectors by improving liquidity and solvency of the host country banking systems (Hellmann and Murdock 1998) exploiting benefits of international diversification (De Haas/Van Lelyveld 2006/2010) improving banking supervision (Peek/Rosengren 2000) Main mechanisms stabilizing cross-border bank lending and domestic credit growth intra-bank lending between parent bank and subsidiary is less prone to asymmetric information (DeHaas/VanLelyveld 2010) parent banks do not jeopardize viability of their subsidiaries (Moreno and Villar 2005) parent banks have access to LOLR, home country governments and IFIs (Broda/Levy Yeyati 2002) Stability benefits of a strong foreign bank presence

© F r a n k f u r t – S c h o o l. d e 9 Key assumptions strong parent banks shocks originated in EMEs If these assumptions are not met, i.e. if parent banks are weak due to shocks in mature economies foreign bank presence can weaken host country banking sectors (Peek/Rosengren 1997, Galindo et al. 2010) Financial crisis triggered in mature economies, weakening parent banks Stability challenges of a strong foreign bank presence

© F r a n k f u r t – S c h o o l. d e 10 Several papers using macro and bank-level data Cross-border bank flows Macro evidence: Foreign banks contributed to more stable cross-border bank flows (EBRD 2009) Bank-level evidence: Syndicated cross-border lending to non-financial firms was more stable to countries where banks have subsidiaries (De Haas et al. 2010) Domestic lending Macro evidence Crisis impact was severe for EMEs with a strong presence of foreign banks that were subsidiaries of parent banks with a US Dollar liquidity shortage. However, domestic banks affected in a similar way. Thus, foreign ownership as such did not aggravate the credit contraction in host countries (Cetorelli/Goldberg 2010) Foreign banks did not aggravate the credit contraction (Aisen/Franken 2010) Bank-level evidence Foreign banks did aggravate credit contraction in Emerging Europe (de Haas et al. 2011) Foreign banks and the global financial crisis

© F r a n k f u r t – S c h o o l. d e 11 Our contribution We test jointly whether EME banking sectors with a higher share of assets held by foreign banks showed a higher degree of stability with regard to cross-border bank flows and domestic lending after the Lehman default (focus on sudden stop phenomena - > Macro data) Regional analysis: Is the contribution of foreign banks to post-crisis financial stability different across regions

© F r a n k f u r t – S c h o o l. d e 12 Cross country study – 84 emerging markets – 5 regions Main variables: cross-border bank flows (BIS International locational banking statistics) claims of BIS reporting banks vis-à-vis countries, quarterly exchange rate adjusted changes change in domestic lending (IMF IFS, national sources) outstanding claims to the private sector (line 22d), first differences foreign bank presence (Claessens et al. 2008) share of banking sector assets held by foreign banks Controls: structural and macroeconomic variables, vulnerability indicators (IMF World Economic Outlook, IFS, World Development Indicators, GFSR, Chinn/Ito 2008, Lane/Shambaugh 2010) Data and empirical model

© F r a n k f u r t – S c h o o l. d e 13 Construction of the FALL measure

© F r a n k f u r t – S c h o o l. d e 14 SUR-estimation to control for correlated residuals benchmark estimations include ‘ExpP GDP GROWTH’ and ‘FIN.OPENNESS’ as other explanatory variables mitigating impact of foreign banks on FALL of flows but not on FALL of lending Benchmark model

© F r a n k f u r t – S c h o o l. d e 15 Benchmark model holds when controlling for structural and macroeconomic variables (inst. quality and change in inst. quality, current account/GDP, commodity price dependence) see tables see tables holds when controlling for internal and external vulnerabilities (debt/gni, exchange rate regime, reserves/debt; foreign liability dollarization; credit/deposit ratio) see tables see tables results are robust to variations of FALL and SURGE measures

© F r a n k f u r t – S c h o o l. d e 16 Regional differences in foreign bank presence

© F r a n k f u r t – S c h o o l. d e 17 Differences across regions  foreign banks have a mitigating impact on flows only in Eastern Europe/Central Asia and Sub-Saharan Africa

© F r a n k f u r t – S c h o o l. d e 18 Testing for foreign bank asset share and regional characteristics  not high foreign bank presence per se is stabilizing  Any peculiar characteristics of bank integration that may explain significant impact of foreign banks in ECA and SSA?  EU accession (single European market)  Colonial ties

© F r a n k f u r t – S c h o o l. d e 19 foreign banks stabilized cross-border bank flows to EMEs during the crisis, but not domestic lending the mitigating impact on cross-border bank flows is a regional phenomenon driven by Eastern Europe/Central Asia and Sub-Saharan Africa we find evidence suggesting that the effect in Eastern Europe is linked to the European integration process We do not find evidence that the effect in Sub-Saharan Africa is due to the long- standing presence of foreign banks due to colonial ties. no evidence that foreign banks aggravated financial instability in EMEs results are robust to changes in the FALL and SURGE measures Conclusions

© F r a n k f u r t – S c h o o l. d e 20 - back up -

© F r a n k f u r t – S c h o o l. d e 21 Structural and macroeconomic variables back

© F r a n k f u r t – S c h o o l. d e 22 External and internal vulnerabilities back

© F r a n k f u r t – S c h o o l. d e 23 Robustness checks – variation of FALL

© F r a n k f u r t – S c h o o l. d e 24 Robustness checks – variation of SURGE

© F r a n k f u r t – S c h o o l. d e 25 Sample countries by region