Following the Global Crisis of 2007-2009, cross-border bank lending has slowed significantly, and non-bank intermediation has risen to fill this gap. This column presents evidence that government intervention has trimmed the global activities of banks along three dimensions: depth, breadth, and persistence. This suggest that bank nationalisation is associated with financial protectionism and reduces financial globalisation.
International financial intermediation has changed significantly since the 2007-2009 Global Crisis – portfolio flows have taken up the slack left by the collapse in bank lending (BIS 2014).
Several reasons have been proposed for this development, including:
- A rise in bank regulation;
- Weakness in loan demand; and
- Political interference in banking as a result of government intervention.1
In this column, we discuss the last explanation.
Government intervention may affect the depth of banking globalisation. On the asset side of a bank’s balance sheet, a disproportionate reduction in cross-border lending following nationalisation constitutes prima facie evidence of a negative impact on banking globalisation, referred to as ‘financial protectionism’ by Rose and Wieladek (2014). As part of government support, banks were often asked to increase domestic lending.2 That is, the ‘home bias’ exhibited by many (see Cerutti and Claessens 2014, Cerutti et al. 2014, De Haas and Van Horen 2012, Giannetti and Laeven 2012, Presbetero et al. 2014, Forbes et al. 2016) would be exacerbated if the bank received a large public intervention, because of the natural preference of a regulator or government towards domestic lending. Furthermore, this effect would be even more pronounced in a crisis, especially when there is a credit crunch as banks face competing demands from regulators and funding constraints (Cerutti and Claessens 2014).
But the ‘depth’ effect need not impact only the asset side of the balance sheet. In a crisis, nationalised banks are also perceived to be the safest home for deposits, as they are owned and backed by the government. Unsurprisingly, Berger and Roman (2015) find that the US Troubled Assets Relief Program (TARP) gave participating institutions a competitive advantage in raising deposits, mainly because those banks were perceived to be safer. Similarly, Acharya and Mora (2015) document a ‘flight to safety’ effect showing that previously liquidity-constrained banks experienced an increase in deposits following the introduction of TARP. This suggests that government intervention may skew bank liabilities toward domestic deposits.
Large banks usually lend and borrow in many different foreign countries. The asset mix across countries differs by bank, often depending on the particular regional or industrial expertise of the bank. For example, Standard Chartered is a large UK bank whose lending is primarily focused on Asia, and Santander, a Spanish bank with substantial operations in Latin America, is now the third largest mortgage lender in the UK. If the authorities impose national political preferences on nationalised banks, leading to a reduction in lending to a particular set of countries, then nationalised banks from different countries would have increasingly divergent asset portfolios. However, nationalised banks from the same country would be expected to have more similar asset portfolios. Does the data support this idea?
Are these effects persistent? US banks provide an insight. Unlike banks in other countries that received public support during the global financial crisis, most American banks have now repaid the funds they received through Troubled Assets Relief Program. Bias against foreign lending could either persist or disappear following Troubled Assets Relief Program exit.
In a recent paper, (Kleymenova et al. 2016), we provide empirical evidence along these three dimensions. Using UK data, we document that following nationalisation, non-British banks allocate their lending away from the UK and increase their external funding (depth). In addition, banks’ cross-country asset allocations converge following nationalisation (breadth). Finally, using US Troubled Assets Relief Program data we show that these effects might not persist after the intervention is unwound (persistence).
The depth effect: British bank assets and liabilities
Given the presence of a large number of domestic and foreign banks that engage in significant cross-border lending, the UK banking system is an ideal place to investigate whether government interventions affected lending and funding (depth) of banks operating in the UK. Using quarterly data from the Bank of England, we document a permanent effect of foreign bank nationalisation as a decrease in the mix of foreign assets in total assets by around 15%. This is an economically significant amount, comparable to those of Rose and Wieladek (2014), and is consistent with the hypothesis that government intervention reduces banking globalisation as external lending is cut back more than domestic lending. However, we do not observe the same effect of nationalisation on British banks. That is, not all governments seem to act the same upon bank nationalisation.
On the liabilities side we find similar results. When a foreign bank is nationalised, it increases the fraction of its foreign liabilities by around 14%, almost exactly the same as the increase in foreign assets. Not only do nationalised foreign banks tilt their lending practices away from the UK; they also tilt their borrowing away, and to a similar degree.
These results are not mechanically implied by those on the asset side. While, in an accounting sense, total assets need to equal total liabilities plus shareholders’ equity, there can be stark differences in the composition because assets in one country can be financed with liabilities from another. In the presence of time effects, our results on the liabilities side can be interpreted as reflecting a bank’s demand for UK versus foreign deposits. In times of uncertainty, nationalised banks, essentially by definition, provide the safest home for deposits. A rise in foreign nationalised bank preference for foreign, as opposed to British, deposits is therefore consistent with the idea that government interventions may have an adverse impact on banking globalisation. We also find a smaller (but statistically significant) effect of foreign capital injections on foreign funding.
The breadth effect – overseas assets
Banks’ foreign assets are often spread across many countries. It is natural to ask if banks’ portfolios become more alike upon nationalisation, reflecting the policy preferences of the government. We ask whether nationalised banks’ cross-country portfolio mixes converge in the wake of nationalisation. We interpret convergence as evidence of government intervention that limits the breadth of banking globalisation.
Using a measure of similarity of banks’ assets, we document that if two banks from different countries are nationalised, the similarity of their cross-country portfolio mixes falls by a large and statistically significant amount. In particular, we find that the similarity of assets is approximately halved when both banks are nationalised. More strikingly, we find that the similarity of a pair of banks’ cross-country portfolio mixes rises significantly when the nationalised banks are from the same country.
These results are consistent with the idea that the external lending preferences of banks from the same country converge after both are nationalised because authorities impose their lending preferences on nationalised institutions. Overall, the reduction in the breadth of financial globalisation is likely to be associated with an increase in systemic risk since banks have less diversified portfolios, a troubling consequence of bank nationalisation.4
How persistent is financial protectionism – the Troubled Assets Relief Program
To assess the durability of these effects, we compare the growth of cross-border lending upon TARP entry and exit. TARP Program is a natural setting to examine persistence, since unlike recent bank nationalisations, many banks have exited Troubled Assets Relief Program. We find some evidence that banks seemed to discriminate against foreign lending after entry into TARP, but there is also evidence (albeit weaker) that this was reversed upon TARP exit. That is, the effects of large public interventions seem to dissipate after the intervention has ended. These effects are small, although not trivial. A counterfactual exercise suggests that aggregate US foreign lending would have been 3.3% higher in the absence of TARP (see Figure 1). This suggests that once public interventions are unwound globally, growth rates in cross-border bank lending may return to those observed before the crisis.
Figure 1. Aggregate foreign lending around TARP (US dollars, billion)
Government ownership is not the only possible friction or reason why cross-border bank lending has remained stagnant since the 2007-2009 crisis (Forbes 2014). In this column, we discuss and show that government ownership could be an important friction inhibiting cross-border bank activity in both the UK and the US. We also provide some evidence that these effects might wear off after the interventions are unwound. If the same mechanism applies to other countries around the world, and if government intervention is indeed an important friction, then global banking intermediation may rebound once again, once banks are privatised[AK1] .
Acharya, V and N Mora (2015), “A Crisis of Banks as Liquidity Providers,” Journal of Finance 70, 1-43.
Berger, A and R A Roman (2015), “Did TARP Banks Get Competitive Advantages?”, Journal of Financial and Quantitative Analysis 50: 1199-1236.
Bank for International Settlements (BIS) (2014), 84th Annual Report, 2013/14.
Cerutti, E and S Claessens (2014), “The Great Cross-Border Bank Deleveraging: Supply Constraints and Intra-Group Frictions”, IMF Working Paper WP/14/180.
Cerutti, E, S Claessens, and L Ratnovski (2014), “Global Liquidity and Drivers of Cross-Border Bank Flows”, IMF Working Paper WP/14/69.
De Haas, R and N Van Horen (2012), "International Shock Transmission after the Lehman Brothers Collapse: Evidence from Syndicated Lending", American Economic Review 102: 231-37.
Forbes, K (2014), “Financial ‘deglobalization’?: capital flows, banks and the Beatles”, speech at Queen Mary University of London.
Forbes, K J, D Reinhardt, and T Wieladek (2016), “The Spillovers, Interactions, and (Un)Intended Consequences of Monetary and Regulatory Policies”, MIT Sloan Research Paper, No. 5163-16, February.
Giannetti, M and L Laeven (2012), “The Flight Home Effect: Evidence from the Syndicated Loan Market during Financial Crises”, Journal for Financial Economics 104: 23-43.
Kleymenova, A, A K Rose and T Wieladek (2016), “Does Government Intervention Affect Banking Globalization?”, CEPR Discussion Paper No. DP11108.
Rose, A K and T Wieladek (2014), “Financial Protectionism? First Evidence”, Journal of Finance 69: 2127-2149.
World Bank (2009), “Global Development Finance. Charting a Global Recovery,” Washington, DC.
1 The April 2015 Global Financial Stability Report provides evidence of financial fragmentation and links it to tighter cross-border regulation, especially due to European bank retrenchment, see chapter 2 of the Report.
2 For example, French banks in receipt of government support pledged to increase lending domestically by three to 4%, and the Dutch bank ING announced that it would lend 25 billion euros to Dutch businesses and households as part of receiving government assistance (World Bank, 2009). Similarly, the US Troubled Assets Relief Program specifically stated that one of its objectives was to increase domestic lending.
3 We thank Takeo Hoshi for pointing this out to us.