Transmission of liquidity risk through global banks: An International Banking Research Network project

Claudia M. Buch, James Chapman, Linda Goldberg, 24 June 2014

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Over the past 30 years, the typical large bank has become a global entity with subsidiaries in many countries. In parallel, financial liberalisation has increased the inter-connectedness of banking systems, with domestic banking systems having become more exposed to shocks transmitted through foreign banks. This globalisation of banking propagated liquidity risk during the financial crisis and the subsequent Eurozone crisis.

As of today, many key questions about banking globalisation remain unresolved:

  • Are international activities of banks stabilising – by making banking networks more resilient to shocks – or destabilising – by allowing for a faster and broader transmission of shocks?
  • How do international activities of banks affect the effectiveness of microprudential policies?
  • Which macroprudential policies are needed and potentially consequential in supporting economic growth and financial stability?
  • Are regulatory and surveillance mechanisms sufficiently geared towards identifying sources of risks inherent in (international) banking?

Of these questions, the international transmission of liquidity shocks has been at the centre of the International Banking Research Network agenda so far. Yet, relatively little is known about how the cross-border operations and internal markets of global banks act as a transmission mechanism for liquidity shocks to spread between countries. Establishing facts is fundamentally a micro-econometric problem and hence bank level data are needed to answer this question accurately. The seminal work by Peek and Rosengren (1997, 2000) provides an early example of how useful bank-level data are in identifying the specific channels of transmission and incidence on host markets. There are two main limitations for conducting this line of research.

  • First, there is a lack of public data on the channels of transmission and balance sheets of global banks.
  • Second, it is difficult to compare the results of different research projects that use sensitive supervisory data collected by banking supervisors and central banks.

The International Banking Research Network

The International Banking Research Network was established in 2012 and brings together central bank researchers from around the world to overcome these limitations. In its first full project year of 2013 the network brought together researchers from a dozen central banks: Austria, Australia, Canada, France, Germany, Hong Kong, Ireland, Italy, Poland, Spain, the UK, and the US, along with IMF and BIS representatives. The goal of the network is to conduct coordinated research on cross-border banking using bank-level data to analyse issues pertaining to global banks. This research aims to be both policy-relevant and academically rigorous. In addition, the research network facilitates the exchange between academia, researchers in central banks, and policymakers on key issues related to international banking. For this purpose, it organizes workshops and conferences to stimulate a fruitful exchange between theoretical and empirical work in international banking and to encourage work along the research frontier. It regularly informs about its activities on its website and shares relevant studies via the associated International Banking Library.

The network researchers agree on a common research question and appropriate econometric specifications. Each central bank research team uses its respective micro-data (including supervisory data) to answer the common research question for banks in their countries, with scope for individualized applications. The purpose of this approach is to facilitate cross-country comparisons between different jurisdictions. The cross-country efforts help inform the common components of banking and banking policy across countries as well as unique country specific features. The transmission of liquidity shocks in lending and through balance sheets exposures of domestic and global banks was the first project chosen and completed by the group.

International evidence of liquidity shock transmission

Recent work conducted by the network uses a consistent methodology based on the work by Khwaja and Mian (2008) and Cornett et al. (2011), and extended as described in the methodological overview within Buch and Goldberg (2014). The figures below illustrate how different categories of lending – domestic lending, foreign lending, and net intra-bank lending – followed quite distinct trajectories across countries.

Figure 1. Lending by selected network countries

Source: Data provided by country teams, in Buch and Goldberg (2014).
Notes: Lending by selected network countries for the first quarter of 2006 through the fourth quarter of 2012. All series are based on data in national currency and indexed to data of the first quarter of 2006. Net due is positive if a domestic bank is a net debtor to its foreign affiliates. Domestic loans in the first quarter of 2006: USA $8,320,683 million; Canada 783,000 million CAD; Germany €1,809,324 million; Ireland €313,332 million; and Poland 359,114 million PLN. Foreign loans in the first quarter of 2006: USA $1,414,507 million; Canada 154,000 million CAD; Germany €630,432 million; Ireland €73,957 million; and Poland 77,717 million PLN. Net due in the first quarter of 2006: USA $219,765 million; Canada 14,600 million CAD; Germany €121,260 million; and Ireland €7,099 million. For Canada, the series refer to all banks including foreign. For Germany, the series refer to German parent banks. For Ireland, the series refer to all residing retail banks including parent and foreign-owned branches and subsidiaries. For Poland, the series refer to banks located in Poland. For the USA, the data series refer to banks with foreign affiliates. Index defined as 100 at 2006Q1.

Each of eleven country teams estimated a panel regression of the domestic banks (both globally active and purely domestic). The variable of interest was the change in various measures of a bank’s balance sheet items that could affect the response of lending to liquidity measures, such as change in foreign loans by the bank or net due balances from foreign affiliates. The independent variables include various (lagged) controls such as the bank’s capital ratio, proxies for size, and various measures of liquidity risk that the banks face. These include a country-specific Libor-OIS spread to measure market liquidity as well as measures of official liquidity support during the crisis.

Meta-analysis

While the individual central bank research teams’ results are of interest, the larger common results are quite pertinent to understand the common features of international bank and liquidity shock transmission. To achieve this, Buch and Goldberg (2014) conduct a meta-analysis on the individual countries results. Several results are observed:

  • First, the common methodology better explains cross-sectional differences in lending by internationally active banks compared with lending by purely domestic banks.
  • Second, the channels of transmission of liquidity shocks to bank lending differ across banks. Deposit funding matters more for the domestically oriented banks. In contrast, internal liquidity management strategies and official liquidity support matter more for the banks with foreign affiliates.
  • Third, the common empirical model explains more of the cross-sectional and time-series variation in domestic lending than in terms of explaining net due to (i.e. intra-bank lending) or foreign lending.

This can be interpreted in terms of the higher stability of domestic lending. At the same time, cross-border lending growth is more sensitive to liquidity risk in relation to the balance sheet characteristics of the banks. One interpretation is that cross-border lending tends to be more subordinated to domestic lending activity as stress conditions change.

Conclusion

The studies conducted in the context of the International Banking Research Network represent the first systematic look across countries using micro data on individual banks by means of a common methodology. This effort provides an important example of the benefits of collaboration and communications across the international research and policy community. Such efforts help support the common goals of macroeconomic stability and financial stability, and they provide lessons that inform appropriate regulatory responses to liquidity risks and other shocks.

References

Buch, C M and L Goldberg (2014), “International Banking and Liquidity Risk Transmission: Lessons from Across Countries”, Federal Reserve Bank of New York Staff Report 675 (May).

Peek, J and E Rosengren (1997), “The International Transmission of Financial Shocks: The Case of Japan”, The American Economic Review 87, 4: 495-505.

Peek, J and E Rosengren (2000), “Collateral Damage: Effects of the Japanese Bank Crisis on Real Activity in the United States”, The American Economic Review 90, 1: 30-45.

Individual Paper Contributions in the 2013 Project of the International Banking Research Network:

Buch, C M, and L Goldberg (2014), “International Banking and Liquidity Risk Transmission: Lessons from Across Countries”, Federal Reserve Bank of New York Staff Report 675 (May).

Bussière M, B Camara, F D Castellani, V Potier and J Schmidt (2014), “Shock Transmission through International Banks – Evidence from France”, Banque de France Working Paper Nb. 485, May. 

Caccavaio M, L Carpinelli, G Marinelli and E Sette (2014), “Shock Transmission through International Banks: the Italian Case”, Banca d'Italia.

Chapman, J and H E Damar (2014), “Shock Transmission through International Banks: Canada.” Bank of Canada.

Correa, R, L Goldberg and T Rice (2014), “Liquidity Risk and U.S. Bank Lending at Home and Abroad.” Federal Reserve Bank of New York Staff Report 676 (May).

Everett, M, J Kelly and F McCann (2014), “Banks’ Internal Capital Markets, Official Liquidity, and International Shock Transmission: an Irish Illustration.” Central Bank of Ireland.

Guttmann, R (2014), “Liquidity Shock Transmission through Australian Banks.” Reserve Bank of Australia.

Hills, R, J Hooley, Y Korniyenko, and T Wieladek (20140, “The International and Domestic Transmission of Bank Liquidity Shocks: Evidence from the UK.” Bank of England.

Kerl, C and C Koch (2014), “Internal Capital Markets, Government Support and How German Banks Adjust to Liquidity Shocks.” Deutsche Bundesbank.

Pawlowska M, D Serwa and S Zajaczkowski (2014), “International Transmission of Liquidity Shocks Between Parent Banks and Their Affiliates: The Host Country Perspective”, Narodowy Bank Polski working paper no. 172.

Segalla, E (2014), “Shock Transmission through International Banks: Austria.” Oesterreichische Nationalbank.

Wong, E, A Tsang and S Kong (2014), “Implications of Liquidity Management of Global Banks for Host Countries – Evidence from Foreign Bank Branches in Hong Kong.” Hong Kong Monetary Authority.

Topics: Institutions and economics, Macroeconomic policy
Tags: global banks, the International Banking Research Network

Deputy President, Deutsche Bundesbank
Assistant Chief of the Financial Studies Division in the Financial Stability Department, Bank of Canada
Vice President of International Research at the Federal Reserve Bank of New York

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