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)| false Galindo, Arturo, Alejandro Izquierdo, and Liliana Rojas-Suarez, 2010, “ Financial Integration and Foreign Banks in Latin America: How Do They Impact the Transmission of External Financial Shocks?,” RES Working Papers 4651, Inter-American Development Bank, Research Department.
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Herman Kamil is an economist at the Western Hemisphere Department, International Monetary Fund, and Kulwant Rai is a PhD student at University of Virginia. The authors are grateful to Sebastian Goerlich for his help in interpreting the data from the Bank for International Settlements, and to Marcos Chamon, Kai Guo, Cesar Serra, Hui Tong and especially Steve Phillips for comments on earlier drafts. Patricia Attix provided excellent editorial assistance. We also thank participants at the XIV LACEA Meetings, the XIV Meeting of the Central Bank Researchers Network of the Americas, the IV FLAR International Conference, the XXIV Central Bank of Uruguay Economic Conference, the IDB’s Research Department seminar and the IMF’s Western Hemisphere Department seminar. Preliminary results were disseminated in the Spring 2009 edition of the IMF Regional Economic Outlook for the Western Hemisphere.
The presence of foreign banks has typically been considered a positive development in emerging market countries by strengthening risk management and corporate governance in host countries (through more efficient allocation of capital, increased competition, and more sophisticated financial services, among others). See Peek and Rosengren (2000), Claessens, Demirgüç-Kunt, and Huizinga (2001), Galindo, Micco, and Powell (2004) and Moreno and Villar (2005) for additional discussion on the costs and benefits of opening the domestic banking sector to foreign competition.
In the paper, we use the following convention: “Latin America” refers to the geographical area of South America, Central America and Mexico, while references to “the Caribbean” are standard. The “region” or “LAC” is used to refer to the full Western Hemisphere excluding Canada and the United States.
Foreign banks belong to more than 20, primarily OECD, countries (referred to as “BIS-reporting countries”). In practice, there can be important distinctions between “foreign” and “BIS-reporting” banks, especially in Central America where regionally operating, non-BIS-reporting banks are common. For ease of exposition, however, in this paper we refer to BIS-reporting banks as international, global, or foreign banks.
Local affiliates include foreign-owned banks established in the host country (subsidiaries) and the agencies of the home country operating abroad (branches).
However, in a few countries in the region (such as Dominican Republic, Ecuador, Guatemala and Venezuela), the banking system is largely domestically owned.
McGuire and Wooldridge (2005) provide detailed discussion on the structure of the BIS consolidated banking statistics.
Cetorelli and Goldberg (2009) analyze the internal capital market transfers between globally-oriented US parent banks and their foreign affiliates in Latin America.
In absolute size, Brazil, Mexico, and Chile accounted for almost 80 percent of all outstanding lending by foreign banks to LAC by end-2008.
This shift in foreign banks’ lending strategy was based, in part, in the acquisition by foreign-owned local affiliates of large local banks, with an already significant local deposit base. This has been particularly important, for example, in Peru, with the entry of Scotiabank (acquiring the third-largest bank on the system) and the reentry of Banco Santander (acquiring a medium-sized local bank) in the late 1990s. For a detailed account of foreign banks’ mergers and acquisitions in the region, see Pozzolo (2008).
Lending by foreign banks to the banking sector in LAC (as a share of total lending) is the lowest among all regions considered. For Asia and the Pacific, the proportion is almost 30 percent, while it is 15 percent for Latin America and the Caribbean.
See also Jara and Tovar (2008) and Caruana (2009) for an analysis of the currency structure of foreign banks’ lending to LAC. Domestic financial dollarization is low in most of the large Latin American countries, and has been systematically declining in the more dollarized ones over the last decade.
Canadian banks account for the largest share of foreign bank assets in the Caribbean. Foreign bank claims on Central America, on the other hand, are relatively diversified between U.S., U.K., and other western European banks.
For a detailed analysis of international banks’ exposure to emerging Europe, see Maechler and Ong (2009).
The exceptions are banks from Germany and France.
Martinez-Peria, Powell and Vladkova-Hollar (2005) analyze annual changes in foreign banks’ claims on Latin American over the period 1985–2000. The authors, however, only focus on the foreign currency-denominated lending by foreign banks to the non-financial private sector in Latin America. Peek and Rosengren (2000), on the other hand, use BIS data to analyze how foreign banks reacted to crises affecting Argentina, Brazil and Mexico during the 1990s.
The dependent variable is “gross” only in the sense that we do not consider changes in the liabilities of foreign banks vis-à-vis LAC countries. However, it is “net” in the sense that they include repayments of loans made by country i.
The 13 LAC borrower countries included in the sample are: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Mexico, Peru, Paraguay, Panama, Uruguay and Venezuela. They accounted for more than 95 percent of the outstanding foreign banks’ lending in the region at the end of 2008. For the rest of the LAC countries not included in the sample, some of the explanatory variables were not available. We exclude from estimation those observations where a BIS-reporting lender country is from LAC (Brazil, Chile, Mexico and Panama).
In addition, foreign banks’ credit to smaller countries constitutes a very small share of total foreign credit, and thus tends to exhibit large variations over a small base.
Excluding these observations, however, significantly reduces the regression fit of our model, since much of the overall variance in the dependent variable is contained in these observations. McGuire and Tarashev (2008) report similar findings.
In the Appendix we provide more details on the definition and sources of the variables used.
EDF is the calculated probability that a bank defaults within the one-year (ahead) period, based on each bank’s market value of assets, its volatility, and its capital structure. We employ data for almost 100 publicly listed banks which are globally active. We thank Patrick McGuire for making available the list of banks.
BIS data are end-period values, expressed in U.S. dollars; changes in these values incorporate valuation changes (exchange rate changes, marking to market of securities, and write-downs of non-performing loans) and so may differ from net lending flows. Currency valuation effects can at times be significant, especially in countries where local currency-denominated lending represents a significant portion of the total.
Foreign bank presence tends to be higher in countries with common language, similar legal systems and banking regulations, and geographical proximity (Claessens and Van Horen, 2008). For example, in Latin America and the Caribbean, 60 percent of foreign banks are headquartered in the United States and Spain, whereas in Europe and Central Asia more than 90 percent of foreign banks are headquartered in the European Union. Fixed effects also account for the special case of Panama, which is a regional banking center and is classified as an offshore center by BIS. It constitutes an outlier in the region, with foreign banks’ claims accounting for 190 percent of GDP.
As discussed by McGuire and von Peter (2009), such dollar shortages became particularly severe after the Lehman bankruptcy, which prompted the Federal Reserve to establish swap lines with other central banks, in particular in European countries.
Our findings are also consistent with Haas and van Lelyveld (forthcoming), who analyze a large bank-level dataset of foreign banks’ subsidiaries across the world to analyze what determines the credit growth of global banks’ affiliates. Their results show that multinational bank subsidiaries with financially strong parent banks are able to expand their lending faster.
In a recent paper, Herrmann and Mihaljek (2009) study the nature of spillover effects in cross-border bank lending flows from advanced to the emerging markets using confidential BIS bilateral data on locational banking statistics. They find that higher global risk aversion and higher expected market volatility seem to have been the most important channels through which spillover effects occurred during the crisis of 2007–08.
The literature suggests that borrowing conditions are likely to tighten for a country that experiences a currency collapse given the balance sheet effects due to currency mismatches.
The positive effect of GDP growth is statistically significant only at the 12% confidence level.
Claims booked outside the recipient economy (i.e., cross-border) are typically funded in international wholesale markets (in foreign currency). In most LAC countries, regulations require that domestic banks (including local affiliates of foreign banks) keep both sides of their balance sheets currency-matched. Thus, the domestic-currency share of total foreign banks’ lending is a reliable indicator of the importance of local sources of funding (except in a few highly dollarized economies like Bolivia, Peru and Uruguay, were a substantial fraction of local deposits are denominated in foreign currency). See also footnote 32.
In this alternative specification, the positive effect of GDP growth on foreign banks’ lending is economically and statistically significant at standard confidence levels.
The share of foreign banks total lending denominated in local currency also serves as a proxy for the share of foreign banks’ total claims on a country held by local affiliates, since cross-border lending is rarely extended in local currency, and lending by local affiliates is mostly denominated in local currency (except in a few dollarized countries like Peru, Bolivia and Uruguay). Data availability limitations preclude directly estimating separate models for cross-border lending and total lending through local affiliates. Such data breakdown is only available since 2005, and only on an aggregate country-level basis.
Analyzing the post-crisis macroeconomic and financial sector performance for 58 advanced countries and emerging, Claessens, Dell’Ariccia, Igan and Laeven (2010) show that banks’ dependence on wholesale funding help to account for the amplification and global spread of the financial crisis.
Using data through 2000, Goldberg (2001) shows that movements in U.S. bank lending to Latin American countries are closely tied to economic conditions in the parent country.
It should be noted the model was estimated over a period that was mostly tranquil (except for the last quarter of 2008), but it is being used to inform future lending growth in the wake of a shock of unprecedented magnitude. That said the model performed very well in predicting the sudden turning point and drop of foreign bank lending to LAC in 2008Q4. With data up to 2008Q4, the model predicted a year-on-year growth in total foreign banks’ lending to LAC for the first quarter of 2009 of 7.5 percent‘ very close to 5.5 percent actually observed (see IMF, 2009a).
Adjusting for exchange rate valuation effects can be important not only in light of the sharp depreciations in the last semester of 2008 (especially in Brazil and Mexico, which together account for about two-thirds of foreign bank claims on the LAC region), but also because these depreciations were preceded by sustained periods of domestic currency appreciation in many emerging markets.
Cross-border lending by foreign banks’ headquarters, in particular, retrenched significantly in 2008, contracting in the final quarter of 2008 at the fastest rate since records began 30 years ago.
Contractions varied in size, but did occur in most countries of the region (see Table 1). Those countries more dependent on cross-border lending—the component of foreign banks lending that is more sensitive to global funding conditions—were the most affected.
In addition to the factors discussed earlier, it is possible that recent bank support or rescue programs in advanced economies may be accelerating the curtailment of cross-border bank flows. In particular, banks receiving public support may feel pressure to expand domestic lending at the expense of their foreign operations.
Using bank-level data for 17 LAC countries between 1996 and 2007, Galindo, Izquierdo and Rojas-Suarez (2010) find that Spanish banks tend to react less than other foreign banks to changes in risk conditions in international capital markets.
The jump observed in the figure in 2008.3 for Spanish banks’ lending in local currency corresponds to the purchase by Santander of ABN-AMRO’s affiliates in Brazil and Uruguay.
Information about residual maturity is available only for cross-border and local affiliates’ lending denominated in foreign currency. For the LAC region as a whole, the share of total foreign banks’ claims with short maturity dropped from 54 percent in 1997 to 42 percent in 2008. Thus, the maturity composition of lending to the LAC region has shifted toward the long term, and refinancing risk remains low compared with developing countries as a whole.
In the case of emerging Europe, foreign-owned banks played a key role in fueling a credit boom during the pre-crisis period. As noted by Porzecanski (2009), foreign-owned affiliates were largely vehicles through which parent banks’ resources were loaned out domestically. Thus, rapid credit growth, large capital transfers to subsidiaries and foreign currency lending were all the result of the expansion strategy of Western Banks.
As discussed in Zettelmeyer at al. (2010), by the time the global financial crisis erupted, emerging Europe was experiencing greater financial vulnerabilities than Latin America. As a result, economic activity in European emerging markets was hit harder than in any other emerging market region.
In a recent paper, Cetorelli and Goldberg (2010) examine the behavior of foreign banks’ lending to countries in Europe, Asia, and Latin America, isolating lending supply shocks to banks in advanced economies from lending demand shocks in recipient countries. Their results suggest that the strongest contraction in foreign banks’ lending on emerging European countries was likely due to effective credit-supply changes by global banks.