The Global Crisis has affected almost all countries worldwide. Its epicentre has been in the core of the advanced economies. After the crisis, deleveraging has been slow (Buttiglione et al. 2014), while the structure of capital flows has changed from debt- to equity-type-instruments (Bussiere et al. 2016). The decline in cross-border bank lending, particularly bank-to-bank flows, has been a key driver of these developments. The crisis has triggered substantive policy responses – fiscal and monetary policy measures have been used actively, stress testing and rules governing recovery and resolution regimes for financial institutions have been further developed, micro-prudential rules and in particular capital requirements have been tightened, and macroprudential toolkits have been assembled.
A recent report by the Bank for International Settlements (BIS), the Financial Stability Board (FSB), and the IMF documents progress made so far with the introduction of macroprudential policy (IMF et al. 2016), but it also states that experience with and lessons from these new instruments remain tentative. Assessing the impacts of the changes in policy and the effects on the real economy is a challenging task.
Among the effects on the real economy are the spillovers of prudential policy measures across borders. A recent cross-country and cross-institution initiative by the International Banking Research Network (IBRN) has explored responses of lending by globally active banks to changes in prudential regulations, distinguishing adjustment across modes of entry, types of policy instruments, and exploring heterogeneity across banks. This column summarises the results of this collaborative research initiative.
The International Banking Research Network
The IBRN was founded in 2012 to inform the academic and the policy debate on current issues related to international banking. It is a multi-country initiative,1 bringing together research teams from 25 central banks, the IMF, the BIS, and the ECB. Most teams have access to confidential bank-level data on domestic and cross-border banking activities.
In the current IBRN initiative, 15 country teams and two cross-country studies examine international spillovers of prudential instruments through credit provision by banks. Spillovers are defined very generally and do not necessarily reflect regulatory arbitrage or policy leakages. The studies focus on two main questions. First, does lending of internationally active banks respond to prudential policies implemented in home and foreign markets, and what are the channels for policy spillovers? Second, to what extent are responses to prudential policies shaped by characteristics of banks and by macroeconomic factors?
To facilitate this analysis, the IBRN collaborated with the IMF and regulatory bodies in the individual countries in order to utilise and extend the Global Macro Prudential Instruments (GMPI) survey, which the IMF conducted in 2013. The collaboration resulted in a new cross-country and quarterly time series database for prudential instruments spanning 64 countries during the period 2000-14 (Cerutti et al. 2016). The instruments covered include general capital requirements, sector-specific capital requirements, interbank exposure limits, concentration limits, loan-to-value ratio limits, and changes in (minimum) reserve requirements.2
The analysis conducted by 15 IBRN countries used a coordinated approach to research whereby the same methodological framework and consistent quarterly data for 2000-14 – both bank-specific and in terms of prudential instruments – is applied in each country. Taken together, the initiative generates broadly relevant insights, going well beyond the single country case studies and capturing the types of insights that can most effectively be gleaned from work using micro-banking data. In a baseline model, all country teams use the same regression models analysing inward or outward transmission of prudential policies. In addition to the baseline model, country teams address issues that are relevant for their countries, given the structure of their banks, their banking systems, or the available micro-banking data. These data cover lending activity, bank ownership, and balance sheet characteristics such as capitalisation, deposit shares, total assets, or the share of illiquid assets. The micro-banking data used in these studies help teams solve the identification problem, which otherwise beleaguers impact assessment studies based on aggregate data.
Buch and Goldberg (2016) provide an overview of the full initiative, including its methodological and database contributions, and a meta-analysis that generates key cross-country results. By design, the empirical studies summarised are very homogenous because all teams use the same baseline regression model. Hence, publication biases that can affect meta-analyses that draw on only published research are not an issue here.
Cross-border prudential spill-overs: What we find
Our first finding is that prudential instruments sometimes spill over across borders through bank lending. The studies detect significant international spillovers in about a third of the regression specifications. These results use conservative criteria applied to the 15 country studies and, specifications that focus on international spillovers along the intensive margin of lending and over a time horizon of several quarters.
Second, international spillovers vary across prudential instruments and are heterogeneous across banks. Bank-specific factors like balance sheet conditions and business models drive, both the amplitude and direction of spillovers to lending growth rates. Spillovers into lending growth from prudential tightening are positive in some cases, and negative in others. This is important for thinking about potential reciprocity and generalisations. Spillovers are most likely to occur via the affiliates of foreign banks hosted in a country, although some evidence exists of inward transmission through home-country global banks. This would be in line with an attempt of domestic banks to preserve market shares and to protect the domestic market from international policy spillovers.
International spillovers of prudential policy on loan growth rates have not been large on average, but have the potential to grow with broader use of macroprudential instruments. The quantitative size of international spillovers has thus far been viewed as small across country studies. Having said that, results of this project are likely to underestimate the full impact of regulations on cross-border banking activities, for three reasons. First, during the period of study, few country-specific macroprudential instruments were activated in the large countries being home and hosts of global banks. Instead, increased capital requirements were enforced worldwide, which limits the scope for regulatory arbitrage. To the extent that macroprudential instruments will be used at a national level to an increasing degree, the potential for leakages and arbitrage is likely to increase as well. Second, we have studied the effects of macroprudential policy along the intensive margin – implications for the entry and exit of financial institutions into foreign markets (i.e. adjustment along the extensive margin) have not been considered. This, too, may understate the full effect of regulations on cross-border activities of banks. Finally, while imposing a common methodology across countries has the advantage of making results comparable and performing an unbiased meta-analysis, it may cloud interesting and important country-specific features of the adjustment process.
Implications for policymakers and researchers
The collaborative effort conducted in the IBRN shows that exploring the effects of regulatory policies requires accounting for heterogeneity across banks. Effects of prudential regulations might be overlooked, and the wrong policy conclusions might be drawn, when using aggregate data or regressions looking at pooled effects across all banks in a given market. Banks, countries, and markets adjust quite differently to the same regulation, both qualitatively and quantitatively. For example, in response to a tightening of capital ratios, there may be a reallocation of market shares from less capitalised to more capitalised institutions with some of this reallocation to foreign financial institutions. In some cases, this can strengthen the global financial system rather than undermine policy effectiveness. Such mechanisms should be considered carefully in assessing the intended and unintended consequences of policy measures.
An additional implication of our research concerns the role of international policy coordination, which some academic research has argued might be motivated by the observation of spillovers and regulatory arbitrage (Jeanne 2012). Our results show that international spillovers are most often observed through the hosted branches and subsidiaries of foreign banks, but also occur through global banks with activities in foreign markets. Policy changes that are coordinated internationally may weaken the incidence of banks moving activities to markets where regulations are less binding, or having significant shifts in market share by countries that have first mover advantages.
The finding that prudential instruments, which tend to be activated in individual countries, spill over into other markets is sometimes voiced as an argument for stronger international coordination through, for instance, reciprocity rules. An important aspect is the specific set of policy goals that countries try to achieve in their use of prudential instruments. For some policy goals, reciprocity may be more important than for others. International spillovers may actually have beneficial effects. In case weaker domestic banks need to reduce lending following a tightening of prudential measures, foreign institutions may allow the domestic economy to receive lending from abroad. Hence, any discussion on reciprocity should start with a definition of the policy goals, spelling out whether the intent is to increase resilience, align distorted incentives, or reign in specific credit excesses that are viewed as potentially undermining financial stability.
Meanwhile, even if the framework and goals of reciprocity are sufficiently articulated, the systematic implementation of reciprocity rules may face practical limitations if put in place at the global level. Our observation of some prudential instrument spillovers into lending activity is tempered by the related point that the probability of statistically insignificant spillovers was a dominant outcome across the broad range of regressions implemented by 15 countries. Moreover, those statistically significant spillovers that were observed often have different signs across countries and instruments, in line with our observation of heterogeneity in international prudential spillover outcomes.
Overall, based on the evidence provided from a range of country experiences with international spillovers of prudential instruments through bank lending, we conclude that there is no one-size-fits-all channel or even direction of transmission that dominates spillovers. While most of the countries in the IBRN initiative are advanced economies, we do not observe that results are systematically different between these countries and participating emerging market countries.
Authors’ note: The authors thank participants of the International Banking Research Network (IBRN) for many thoughtful exchanges and contributions. The views expressed in this column are solely those of the authors and should not be interpreted as reflecting the view of the Banque de France, the Federal Reserve Bank of New York, the Federal Reserve System, or the Deutsche Bundesbank. All errors are our own.
Buch, C M, and L S Goldberg (2016), “Cross-Border Prudential Policy Spillovers: How Much? How Important? Evidence from the International Banking Research Network”, NBER Working Paper no. 22874.
Bussière, M, J Schmidt, and N Valla (2016), “International Financial Flows in the New Normal: Key Patterns (and Why We Should Care)”, CEPII Policy Brief 2016-10.
Buttiglione, L, P R Lane, L Reichlin, and V Reinhart (2014), Deleveraging? What Deleveraging?, Geneva Reports on the World Economy 16, ICMB and CEPR.
Glick, R, and A K Rose (1999), “Contagion and Trade: Why Are Currency Crises Regional?” Journal of International Money and Finance 18(4): 603-617.
International Monetary Fund (2015), “International Banking After the Crisis: Increasingly Local and Safer?”, in Global Financial Stability Report, Washington DC.
International Monetary Fund, Financial Stability Board, and Bank for International Settlements (2016), “Elements of Effective Macroprudential Policies: Lessons from International Experience”.
International Monetary Fund (2013), “Key Aspects of Macroprudential Policy”, Background Paper, Washington DC.
 The current list of participating central banks and institutions as well as country studies are available at http://www.newyorkfed.org/IBRN/index.html.
 The database is available at https://www.newyorkfed.org/ibrn.