1. 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

2. 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?

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

4. 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)

5. 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

6. Data International panel – Bankscope – 900 publicly listed banks from 83 countries – 1999-2009 period Size of unconsolidated subsidiary relative to size of consolidated parent bank Alternative internationalization measures Weighted by parent’s ownership share

7. 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

8. 725 194 100 74 41 43 27 19 13 11 87 555 11 3 211 3 12 0 200 400 600 800 Frequency 0.05.1.15.2.25.3.35.4.45.5.55.6.65.7 Foreign Liability Share 568 219 89 48 39 21 11 4 32 5 2 11 0 200 400 600 Frequency 05101520 Countries Internationalization measures

9. VariablesObsMeanStd. Dev.MinMax Foreign liabilities share37120.0200.06801.640 Concentration37100.9660.0900.2711 Foreign concentration13070.8180.2430.1851 International37120.2740.44601 Countries37121.5561.337122 Log of countries37120.2730.49803.091 Interest expense37120.0330.0230.0000.289 Deposit growth28860.0850.245-3.5272.096 Lagged equity36990.0920.0700.0000.948 Lagged liquidity37110.1580.1550.0010.974 Lagged profit37120.0130.024-0.4370.293 Inflation difference1299-0.0020.061-0.4300.451 Summary stats

10. Correlations Interest expense Deposit growth Foreign liabilities share Concentration Foreign concentration InternationalCountries Log of countries Interest expense 1 Deposit growth -0.087***1 Foreign liabilities share 0.123***-0.0261 Concentration -0.149***0.023-0.966***1 Foreign concentration 0.0060.028-0.112***0.183***1 International 0.169***-0.0250.384***-0.528***-0.271***1 Countries 0.096***-0.0180.373***-0.500***-0.646***0.678***1 Log of countries 0.140***-0.0190.415***-0.561***-0.668***0.893***0.915***1

11. 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

12. 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

13. 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***-0.149-0.421** (0.008)(0.021)(0.010)(0.015)(0.110)(0.148)(0.167)(0.209) Lagged profit-0.074*-0.055-0.071*-0.06-1.175-1.341-1.182-1.32 (0.038)(0.042)(0.038)(0.041)(1.111)(1.134)(1.113)(1.145) Lagged profit* Foreign liabilities share -1.741-1.098*25.981**22.930* (1.078)(0.562)(10.882)(13.842) N3712 3673 2938 2903 R-sq0.340.3470.3480.3510.0940.0970.0940.096

14. Alternative measures with interest expense (1)(2)(3)(4)(5)(6)(7)(8)(9)(10) Lagged profit-0.074*-0.953*-0.118***-0.242-0.074*-0.057-0.074*0.021-0.074**-0.056 (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 concentration0.0030.001 (0.003)(0.004) Lagged profit*Foreign concentration0.138 (0.329) International-0.0010.000 (0.001)(0.002) Lagged profit*International-0.125** (0.050) Countries-0.0000.001 (0.000) Lagged profit*Countries-0.082** (0.041) Log of countries-0.0010.001 (0.001) Lagged profit*Log of countries-0.167** (0.071) N3710 1307 3712 R-sq0.3380.3440.4100.4110.3360.3400.3360.3400.3360.341

15. (1)(2)(3)(4)(5)(6)(7)(8)(9)(10) Lagged profit-1.17313.431**2.479**4.552-1.137-1.606-1.143-3.605**-1.133-1.627 (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-14.816** (6.768) Foreign concentration0.0490.086 (0.042)(0.063) Lagged profit*Foreign concentration-2.754 (4.037) International0.026-0.032 (0.035)(0.034) Lagged profit*International4.188*** (1.454) Countries-0.001-0.019** (0.007) Lagged profit*Countries2.088*** (0.670) Log of countries0.014-0.041 (0.031)(0.029) Lagged profit*Log of countries4.764*** (1.479) N2937 1158 2938 R-sq0.0940.0970.2070.2080.0930.1010.0930.1010.0930.102 Alternative measures with deposit growth

16. 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*0.0590.035***0.014-0.301***-0.408***-0.357**-0.520** (0.034)(0.041)(0.014)(0.015)(0.085)(0.109)(0.141)(0.220) Lagged profit -0.109*** -0.098**-0.105***0.7230.6220.7310.631 (0.039) (0.038) (0.999)(1.008)(1.001)(1.013) Lagged profit*Lagged foreign liabilities share 0.0161.48911.92513.351 (1.002)(1.085)(8.554)(10.588) N 2364 2339 2407 2381 R-sq 0.338 0.3360.3380.0770.0780.0770.078

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

18. IV estimation interest expense - 1 No restrictionForeign liabilities share < 0.3 (1)(2)(3)(4)(5)(6) Lagged profit -0.0070.015-0.0010.018-0.002-2.872** (0.031)(0.025)(0.028)(0.023)(0.028)(1.453) Foreign liabilities share 0.0690.158**0.0690.163** (0.047)(0.077)(0.045)(0.075) Lagged profit* Foreign liabilities share -6.396**-6.035* (3.118)(3.090) Concentration -0.040-0.085** (0.026)(0.040) Lagged profit*Concentration 2.892** (1.463) N 2539 2515 2537 R-sq 0.3160.2950.3350.3160.3280.308 Excluded instruments F-test0.0070.0010.0020.0050.0020.003 Hansen J-test (p-value) 0.8420.7320.9760.8270.8660.767 Endogeneity test (p-value) 0.1280.1030.1090.0410.1090.057

19. IV estimation interest expense - 2 (1)(2)(3)(4)(5)(6) Lagged profit-0.0030.0100.0080.357**0.0000.038 (0.029)(0.028)(0.027)(0.180)(0.028)(0.026) International0.0100.015 (0.007)(0.010) Lagged profit*International-0.290 (0.427) Countries0.0030.005 (0.003)(0.004) Lagged profit*Countries-0.320** (0.162) Log of countries0.0110.020* (0.007)(0.010) Lagged profit*Log of countries-0.774* (0.442) N2539 R-sq0.3150.3030.2950.2870.2930.254 Excluded instruments F-test0.0070.0390.0220.0460.0060.007 Hansen J-test (p-value)0.6180.3400.5390.4250.6970.427 Endogeneity test (p-value)0.1730.1090.2260.3060.1270.147

20. IV estimation deposit growth - 1 No restriction Foreign liabilities share < 0.3 (1)(2)(3)(4)(5)(6) Lagged profit -2.860**-5.197***-2.743*-4.558**-2.847**114.459** (1.403)(1.911)(1.414)(1.788)(1.401)(47.854) Foreign liabilities share -2.005-7.035**-2.291-5.945** (1.621)(3.225)(1.549)(2.647) Lagged profit* Foreign liabilities share 240.124**206.453** (101.275)(85.654) Concentration 1.1533.922** (0.946)(1.676) Lagged profit*Concentration -119.235** (48.831) N 1846 1829 1846 R-sq 0.082-0.2290.094-0.0430.088-0.185 Excluded instruments F-test 0.0170.0000.0330.0000.0120.000 Hansen J-test (p-value) 0.1550.6010.2980.5520.1310.286 Endogeneity test (p-value) 0.1370.0050.0500.0040.1630.009

21. IV estimation deposit growth - 2 (1)(2)(3)(4)(5)(6) Lagged profit-2.866**-0.710-3.012**-8.104*-2.943**-2.948 (1.395)(2.304)(1.443)(4.184)(1.405)(1.805) International-0.1050.168 (0.358)(0.366) Lagged profit*International-8.550 (13.992) Countries-0.021-0.027 (0.069)(0.064) Lagged profit*Countries4.629 (3.128) Log of countries-0.0960.006 (0.272)(0.266) Lagged profit*Log of countries8.200 (9.871) N1846 R-sq0.1030.0400.1140.1160.1050.112 Excluded instruments F-test0.0470.1560.0190.0110.0160.001 Hansen J-test (p-value)0.0340.0250.0260.0410.0300.020 Endogeneity test (p-value)0.7570.8650.6880.9230.6940.784

22. 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**0.0030.019**0.011 (0.008) Lagged profit-0.070*-0.060-0.071*-0.062-0.102***-0.110***-0.101***-0.105*** (0.038)(0.040)(0.038)(0.041)(0.039)(0.038) Lagged profit*Foreign liabilities share -0.936**-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**0.2410.267* (0.155)(0.157)(0.147)(0.145) N3704 3666 2358 2329 R-sq0.3600.3620.3600.3620.3390.3420.3380.340

23. 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

24. 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