International Banking Safer Since Crisis

Banks have cut cross-border lending, rely more on local lending by subsidiaries

Makes financial systems in host countries safer

Policymakers should promote stable international banking

In new analysis that is part of the latest Global Financial Stability Report, the IMF said that cross-border lending compounds adverse domestic and global shocks to a country’s economy and financial system. Countries with higher exposure to cross-border lending experience a more significant reduction of credit growth during both domestic and global financial crises. Local lending by foreign affiliates, however, behaves differently.

How it works

In principle, lending by foreign banks can be a double-edged sword for the financial stability of a country that receives such lending (the host country). On the one hand, foreign banks are less likely to be affected by local troubles and may therefore help stabilize credit growth when host economies undergo stress. On the other hand, foreign banks are likely to transmit global shocks to host countries.

Banks generally have two ways to conduct their international lending business: directly across borders or through their foreign affiliates. In the first case, loans are made directly from headquarters to firms or other banks in another country. In the second, branches or subsidiaries (affiliates) controlled by the banking group lend to residents of the country where they are located. These two forms of international banking turn out to have very different implications for the host country’s financial stability.

While cross-border banking linkages tend to aggravate the effects of adverse domestic and global shocks on credit in host countries, local lending can play a stabilizing role during domestic crises.

“Around domestic crises, foreign-owned affiliates tend to reduce their credit less than domestic banks,” said Gaston Gelos, Chief of the Global Financial Stability Analysis Division at the IMF. “This is particularly true if the parent bank of the subsidiary is well-capitalized and has stable funding sources.”

Some banks retrench, others step in

The relative shift towards more subsidiary-based lending since the crisis is therefore likely to have positive implications for the financial stability of the host country.

Since the global financial crisis, tighter regulations on banks, both general and specific to their international operations, combined with a need to...