Internal Capital Markets and the Funding of Subsidiaries of Multinational Banks

• DOI: http://doi.org/10.1111/infi.12055
• Author: Isabel Maria Monteiro Lavrador,Mohamed Azzim Gulamhussen
• Published date: 01 December 2014
• Date: 01 December 2014

Internal Capital Markets and the

Funding of Subsidiaries of

Multinational Banks

Mohamed Azzim Gulamhussen

y

and

Isabel Maria Monteiro Lavrador

z

y

ISCTE Business School, Instituto Universitário de Lisboa, Lisboa, Portugal,

and

z

European Central Bank, Frankfurt am Main, Germany

Abstract

We study the factors that determine the debt funding of subsidiaries of

multinational banks. Our findings indicate that the funding of

subsidiaries is determined by the internalization advantages of the

parent bank and the home country, in addition to the characteristics of

the subsidiary and the host country. Subsidiaries of multinational banks

adjust the level of their funding by virtue of their affiliation with their

parent’s multinational network. Multinational banks may exploit their

internalization advantages to secure funding via subsidiaries. Our find-

ings suggest that gaps in regulation and supervision between host and

home countries have t he potential to und ermine the sound f unctioning

of the global financial system.

The views expresse d in this paper are those o f the authors and do not necessarily repres ent

those of the institu tions with which the aut hors are affiliated. We acknowledge fina ncial

support from ‘Fundaçã o para a Ciência e Tecnologia’(PTDC/EGE‐ECO/114977/2009).

International Finance 17:3, 2014: pp. 357–380

DOI: 10.1111/infi.12055

© 2014 John Wiley & Sons, Ltd.

I. Introduction

The literature on multinational banks’overseas subsidiaries most often views

these entities as integrated into the local markets where they are located by

virtue of accepting funding f rom local depositors and investors and gran ting

credit to local borrowers; in addition, these subsidiaries fall under local

supervisory and regulatory oversight (see, among others, Heinkel and Levi

1992; Cerutti et al. 2007). A recent strand of literature challenges this view by

arguing that the asset levels of banks’overseas subsidiaries are adjusted by

virtue of their integration into their parent banks’multinational networks

(De Haas and Naaborg 2006; De Haas and Van Lelyveld 2010).

The former set of studies views banks’overseas subsidiaries as entities

autonomous of their parent institutions: they operate in overseas markets,

accept funding from local depositors and grant credit to local customers in

the same way as purely domestic banks. The latter set of studies views banks’

overseas subsidiaries as benefiting from both the internalization advantages

of their parents and the possibility of tapping into the internal market of

their multinational networks.

We advance the understanding of the activity of multinational banks’

subsidiaries by investigating whether their debt funding depends on not

only local subsidiary and host‐country characteristics but also parent and

home‐country internalization advantages. To answer this question, we

assemble new data on 80 subsidiaries of 27 multinational banks from 1998

to 2008. Our findings indicate that the funding of multinational banks’

subsidiaries is determined by not only local subsidiary and host‐country

characteristics but also by parent and home‐country internalization advan-

tages. In addition, our findings indicate that banks’overseas subsidiaries

benefit from the internal markets of their parents’multinational networks.

The remainder of this paper is structured as follows. In Section II, we

review the existing literature on internal capital markets and the funding of

multinational bank subsidiaries. In Section III, we describe the empirical

strategy and the construction of the panel and present the variables and

descriptive statistics. In Section IV, we outline the main findings. In

Section V, we summarize the major implications of our study.

II. Multinational Banks and Their Internal Markets

Banks accumulate two main types of information in the course of their

activity in the domestic market: (1) information on their customers’status

and needs based on their deposits and debt; and (2) technical (e.g. deriva-

tives and portfolio management) and market‐making (e.g. marketing of

358 Mohamed Azzim Gulamhussen and Isabel Maria Monteiro Lavrador

© 2014 John Wiley & Sons, Ltd.