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The report reflects information available up to June 30, 2017. Contents Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Abbreviations and Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 Conceptual Framework, Stylized Facts, and the Role of Policy . . . . . . . . . . . . . . . . . . . 21 2 Brick-and-Mortar Operations of International Banks . . . . . . . . . . . . . . . . . . . . . . . . . . 41 3 Cross-Border Lending by International Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Statistical Appendixes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119 A Basic Data on Financial System Characteristics, 2013–15 . . . . . . . . . . . . . . . . . . . . . 121 B Key Aspects of International Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137 Bibliography. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 v vi CONTENTS GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOXES O.1 Main Messages of This Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 O.2 Views on International Banking by Practitioners: Global Financial Development Barometer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 O.3 Navigating This Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 1.1 A Brief Historical Perspective on International Banking . . . . . . . . . . . . . . . . . . . . . .22 1.2 Useful Definitions for Understanding International Banking in the Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 1.3 The Rise of International Microfinance Institutions . . . . . . . . . . . . . . . . . . . . . . . . .28 1.4 What Constitutes a Foreign Bank Claim? An Overview of the Banking Statistics of the Bank for International Settlements (BIS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29 1.5 What Data Can Be Used to Understand the Activities of International Banks? . . . . .30 2.1 How Do Banks Expand Abroad? Branches or Subsidiaries? . . . . . . . . . . . . . . . . . . .45 2.2 Macroprudential Policies to Manage Credit Growth . . . . . . . . . . . . . . . . . . . . . . . .47 2.3 Foreign Banks in Africa: The Case of Ecobank . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48 2.4 Dynamics of Postcrisis International Bank Retrenchment: From Globalization to Regionalization? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 2.5 Improving Rural Finance in Albania through Knowledge Exchange . . . . . . . . . . . . .53 2.6 Foreign Exchange Risk: The Case of Latvia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55 2.7 The Lending Cyclicality of Foreign Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57 2.8 The Transmission of International Monetary Policy via Foreign Banks in Mexico . .59 2.9 Lending Technologies of Foreign Banks and Their Approach to SME Lending . . . . .63 2.10 The Global Expansion of Chinese Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 2.11 Decentralized Global Banks and Multiple-Point-of-Entry Resolution . . . . . . . . . . . .72 2.12 The European Banking Union . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 2.13 Intermediate Cooperation Approaches: The ASEAN and Australia–New Zealand Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 2.14 Intermediate Cooperation Approaches: The WAEMU Case . . . . . . . . . . . . . . . . . . .76 3.1 The Big Sur: Beyond Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .93 3.2 Bank-Intermediated Trade Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .94 3.3 Foreign Banks and the International Transmission of Monetary Policy. . . . . . . . . . .98 3.4 Substitution Effects during Crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103 3.5 De-Risking in Correspondent Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105 3.6 Fintech in China: An Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .109 FIGURES BO.2.1 The Impact of Global and Regional Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 O.1 Cross-Border and Local Claims by Foreign Banks, 2005–15 . . . . . . . . . . . . . . . . . . .7 O.2 Number of Entries and Exits of Foreign Banks, 1995–2013. . . . . . . . . . . . . . . . . . . .8 O.3 Share of Foreign Bank Assets, by Region, 2005–13 . . . . . . . . . . . . . . . . . . . . . . . . . .8 GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 CONTENTS vii O.4 Direction of Cross-Border Bank Lending, before and after the Global Financial Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 O.5 Share of Regional Foreign Banks among Foreign Banks, Country-Level Averages, 1997–2013. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 O.6 Trends in Bank Size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 O.7 Share of Developing Countries with Restrictions on Foreign Bank Entry through Alternative Modes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 O.8 Share of Home and Host Countries That Tightened Macroprudential Policies, 2005–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 O.9 Change in Bank Lending Associated with a 1 Percent Increase in Growth in GDP per Capita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 O.10 Contribution of Local Deposits to Banks’ Total Funding . . . . . . . . . . . . . . . . . . . . .16 O.11 Volume of Debt Issuance over Time for Real Purposes . . . . . . . . . . . . . . . . . . . . . . .17 O.12 Average Change in Long-Term Debt Financing, by Ownership Type . . . . . . . . . . . .17 B1.2.1 How the International Banking System Works . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 1.1 Foreign Financial Inflows to Developing Countries: Syndicated Loans, Bonds, and Foreign Direct Investment, 2000–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 1.2 Foreign Claims Reported to BIS by Counterparty Income Level, 2000–15 . . . . . . . .27 B1.4.1 A Taxonomy of Foreign Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29 1.3 Lending by International Banks: Foreign Claims on Counterparty Nonbank Private Sector (Country-Level Average by Region) and on Counterparty Sectors (Country-Level Average by Income Level), 2005–14 . . . . . . . . . . . . . . . . . . . . . . . .31 1.4 Cross-Border Bank Flows: Cross-Border Claims on Counterparty Regions and Foreign Claims on Counterparty Economies by Position Type and Income Level, 2005–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32 1.5 Foreign Bank Presence through Subsidiaries: Share of Foreign Banks of Total Banks (Country-Level Average by Region, 1997–2013) and Share of Foreign Bank Assets of Total Bank Assets (Country-Level Average by Region, 2005–13) . . .33 1.6 Rise of South–South Banking: Foreign Claims by Banks in BIS-Reporting Countries (2003–15) and Nationality of Majority Ownership of Banks in Developing Countries (1995–2013) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34 1.7 Total Assets of Largest Banks (Absolute Amounts, on a Rolling Basis) and Size of Assets in Relation to National Economies (Combined Assets of Top Five Banks, Country-Level Average by Region), 2005–14 . . . . . . . . . . . . . . . . . . . . . . . .35 1.8 Regulatory Restrictions on Foreign Bank Entry and Ownership (Country-Level Average), 2000–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35 B2.3.1 Distribution of Ecobank’s Branches and Offices (2015) and Assets (2011 and 2015) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49 B2.4.1 Growth over Time of Foreign Banks by Number of Subsidiaries (2000–13) and Average Assets (2005–13) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 B2.4.2 Acquisitions, Transferals, Greenfield Entries, and Closures of Foreign Banks, 2000–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52 B2.7.1 Change in Bank Lending Associated with a 1 Percent Increase in GDP per Capita, 1999–2010. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57 viii CONTENTS GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 2.1 Contribution of Local Deposits, Equity, and Short-Term and Long-Term Funding to Total Bank Funding, 2000–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58 B2.10.1 Chinese Banks in the World: A Snapshot of Chinese Large Commercial Banks, 2005–15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 2.2 Trends over Time of Foreign Bank Subsidiaries in Developing Countries by the Type of Country in Which Each Bank Is Headquartered, 2001–13 . . . . . . . . . . . . .67 B2.11.1 Liquidity and Cross-Border Funding of European Bank Subsidiaries in Europe and Central Asia and Latin America and the Caribbean Regions . . . . . . . . . . . . . . .72 3.1 Restrictions to Capital Flows: Average across Economies of the South, 1990–2013. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86 3.2 Direction of Cross-Border Bank Lending, Selected Years . . . . . . . . . . . . . . . . . . . . .87 3.3 Average Net Syndicated Loan Outflows by Region, 2001–14 . . . . . . . . . . . . . . . . .89 3.4 Average Share of Intraregional Syndicated Loans of Total Cross-Border Syndicated Loans, by Region, 2001–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .89 3.5 Evolution of Cross-Border Bank Claims by Partner Economy, 2001–14 . . . . . . . . .90 3.6 Evolution of Cross-Border Syndicated Loan Flows by Partner Economy, 1996–2014. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .91 3.7 Share of Lending to the South from the North and the South, 2001–14 . . . . . . . . . .92 B3.1.1 Direction of Foreign Direct Investment and Cross-Border Portfolio Investments, Selected Years. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .93 B3.2.1 Bank-Intermediated Trade Finance in Emerging and Advanced Economies: Quarterly Trends, 2005–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 3.8 Total Amount Raised in Syndicated Loan Markets by High-Income and Developing Countries, 1991–2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 3.9 Volume and Composition of Loan Issuance over Time, 2003–14 . . . . . . . . . . . . . .100 3.10 Composition of Debt Issuance over Time, 2003–14 . . . . . . . . . . . . . . . . . . . . . . . .101 B3.5.1 Correspondent Banking: Recent Developments . . . . . . . . . . . . . . . . . . . . . . . . . . .106 B3.6.1 Fintech “Unicorns”: Fintech Firms with a Valuation of over $1 Billion, 2016 . . . .109 3.11 How Blockchain Works . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .112 3.12 The Remittances Market, 2011–16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113 MAPS 2.1 South–South Banking Subsidiary Networks, 2005 and 2014 . . . . . . . . . . . . . . . . . .43 3.1 South–South Lending Connections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 A.1 Depth—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .129 A.2 Access—Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .130 A.3 Efficiency—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .131 A.4 Stability—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .132 A.5 Depth—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133 A.6 Access—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .134 A.7 Efficiency—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .135 A.8 Stability—Financial Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136 GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 CONTENTS ix TABLES BO.2.1 Selected Results from the Financial Development Barometer . . . . . . . . . . . . . . . . . . .6 B1.3.1 Evolution of Greenfield MFIs in Sub-Saharan Africa during Initial Years of Operation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28 B3.3.1 Monetary Policy Interest Rates and the Cross-Border Syndicated Loan Volume . . . .99 3.1 Debt Issuance Change during the Global Financial Crisis . . . . . . . . . . . . . . . . . . . .101 B3.4.1 Market Choice and Domestic Banking Crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . .104 A.1 Economies and Their Financial System Characteristics, 2013–15 . . . . . . . . . . . . . .121 A.1.1 Depth—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .129 A.1.2 Access—Financial Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .130 A.1.3 Efficiency—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .131 A.1.4 Stability—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .132 A.1.5 Depth—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133 A.1.6 Access—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .134 A.1.7 Efficiency—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .135 A.1.8 Stability—Financial Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136 B.1 Foreign Penetration and Internationalization of Financial Systems, 2014 . . . . . . . .137 Foreword T his Global Financial Development Report is a key component in the ongoing debate over the role of international of the causes and effects of bank globaliza- tion—in particular, for economic growth, shared prosperity, and poverty reduction. banking in supporting economic development For many years, the World Bank Group and promoting shared prosperity. has supported developing countries in reap- This report, the fourth in its series, comes ing the benefits of international banking while at a critical time when the global reform also minimizing risks to financial stability. agenda is shaping financial globalization—in This work is even more critical as the world particular, banking. During the decade prior seeks to meet the rising aspirations of the to the 2007–09 global financial crisis, bank- poor. Crowding in private sector investment ing activities across national borders increased will transform the billions of dollars that are dramatically. In many cases, the trend brought available in development assistance into tril- benefits, including additional capital, liquid- lions for investment in developing countries. ity, and technological improvements, which International banks are one conduit for these resulted in greater efficiency and financial private sector investments, and effective finan- development. The global financial crisis, how- cial sector policies will be key to creating the ever, led to a reevaluation of the virtues of stability that can attract private capital. bank globalization, with global banks seen as The report provides a careful review and culpable for transmitting the financial crisis synthesis of recent and new research; it also across borders. In fact, the Financial Stabil- notes where more research is needed. It argues ity Board (FSB), the G20, and policy makers that international banking is no panacea for throughout the developing world voiced con- guaranteeing financial development and sta- cerns about the effects of global banking. bility, and that the right policies are central to The Global Financial Development Report generating benefits, while avoiding negative 2017/2018 offers new research and data that repercussions associated with cross-border help fill gaps in the knowledge of international banking. Consequently, to secure contract banking and contributes key insights to the enforcement, governments and international policy discussion. The report provides stylized bodies must strengthen regulations, improve facts and examines existing and new evidence information availability, and enhance legal GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 xi xii FOREWORD GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 and judicial systems. In designing policies to governments, international financial institu- overcome institutional weaknesses, it is also tions, nongovernmental organizations, think important to take into account the differences tanks, academics, the private sector, donors, in bank characteristics and conditions in both and the broader development community. home and host countries. We hope that this year’s Global Finan- Jim Yong Kim cial Development Report will prove useful President to a wide range of stakeholders, including The World Bank Group Acknowledgments T he Global Financial Development Report 2017/2018 reflects the efforts of a broad and diverse group of experts, both assistance. Inputs were received from Saniya Ansar (chapter 1), Leila Aghabarari (chap- ter 2, box 2.3), David Gerbrands and Bjorn inside and outside the World Bank Group. Schrijver (chapter 2, box 2.5), Javier Pablo The report was produced by the World Bank Garcia Tolonen, and Santiago Fernandez de Research Department in collaboration with Lis Alonso (chapter 2, box 2.11), Nan Zhou the Finance and Markets Global Practice, the (chapter 2, box 2.10, chapter 3, boxes 3.2, Chief Economist’s Office at the International 3.5, and 3.6). Finance Corporation (IFC), and the Multi- Shanta Devarajan (Senior Director of lateral Investment Guarantee Agency (MIGA). Development Economics), Mahmoud Moreover, it includes inputs from a wide range Mohieldin (Senior Vice President), and Joa- of units within the World Bank Group. quim Levy (Managing Director and World Asli Demirgüç-Kunt was the report’s direc- Bank Group Chief Financial Officer) provided tor. Ata Can Bertay was the task manager of overall guidance and valuable advice. the project. The main authors in charge of the External advisors to the report included chapters were: Ata Can Bertay and Miriam Viral Acharya (New York University, Stern Bruhn (chapter 1), Robert Cull and Claudia School of Business, and Deputy Governor Ruiz Ortega (chapter 2), Juan Jose Cortina of Reserve Bank of India); Franklin Allen Lorente, Ruth Llovet Montanes, and Sergio (Executive Director of the Brevan Howard Schmukler (chapter 3). Nan Zhou was respon- Centre and Professor of Finance and Eco- sible for the statistical appendices and was nomics at Imperial College London); Thor- part of the core team. Maria Soledad Mar- sten Beck (Professor of Banking and Finance tínez Pería and Jeanne Verrier contributed to at Cass Business School in London); Allen the concept note. Other authors that provided Berger (Professor of Banking and Finance at key contributions to the chapters include University of South Carolina); Charles Calo- Nan Zhou (chapters 1, 2, and 3), and Maria miris (Henry Kaufman Professor of Financial Soledad Martínez Pería and Katia D’Hulster Institutions at Columbia University); Stijn (chapter 2). Leila Aghabarari, Serhat Guven, Claessens (Head of Financial Stability Policy, and Can Sever provided excellent research Bank of International Settlements); Patrick GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 xiii xiv ACKNOWLEDGMENTS GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Honohan (Senior Fellow at the Peterson Insti- and Alfonso Garcia Mora (chapter 3) and the tute for International Economics and Former participants of these seminars. Governor of the Central Bank of Ireland); In the Bank-wide review of the concept Harry Huizinga (Professor at Tilburg Univer- note and of the report, substantial comments sity); and Ross Levine (Willis H. Booth Chair were received from Mahmoud Mohieldin in Banking and Finance at the University of (Senior Vice President); Yvonne M. Tsikata California at Berkeley). (Vice President and Corporate Secretary); The team also received valuable peer Michael Edwards, Erik Feyen, Aurora Fer- reviews and guidance from other staff mem- rari, and Pietro Calice (all Finance and Mar- bers at the World Bank Group, including Dan kets Global Practice); Keiko Honda, Merli Biller, Marcos Brujis, Ted Haoquan Chu, Baroudi, Dan Biller, Persephone Economou, Augusto de la Torre, Neil Gregory, Ceyla Paz- Paul Barbour, Gianfilippo Carboni, and arbasioglu, Gloria Grandolini, and Peer Stein. Petal Jean Hackett (all Multilateral Invest- Aart Kraay reviewed the concept note and ment Guarantee Agency); Nena Stoiljkovic drafts of the report for consistency and qual- Hans Peter Lankes, Bill Haworth, Facundo ity multiple times. Martin, and Mahima Khanna (all Interna- Ted Haoquan Chu and Neil Gregory were tional Finance Corporation); Xiaoqing Yu, the key contacts at IFC, Ceyla Pazarbasioglu Shabih Mohib, Tatiana Nenova, and Nikola at the Finance and Markets Global Practice, Spatafora (all East Asia and Pacific Region); and Dan Biller at MIGA. The authors ben- Mariam J. Sherman and David Gould (both efited from informal discussions, and received Europe and Central Asia Region); Antonella valuable suggestions and other contributions Bassani, Samia Msadek, Jean Denis Pesme, from Irina Astrakhan, Stefan Avdjiev, Ana Christina Wood, and Omer Karasapan (all Maria Aviles, Steen Byskov, Cesar Calde- Middle East and North Africa Region); ron, Pietro Calice, Katia D’Hulster, Shantay- Martin Rama and Martin Melecky (both anan Devarajan, Michael Edwards, Aurora South Asia Region); Makhtar Diop, Cesar Ferrari, Neil Gregory, Mario Guadamillas, Calderon, Souleymane Coulibaly, Vinaya David Michael Gould, Erik Feyen, William Swaroop, and Luis Diego Barrot (all Sub- Haworth, Frank Heemskerk, Leora Klapper, Saharan Africa Region); Caroline Heider, Emmanuel K. Lartey, William Maloney, Yira Anjali Kumar, Beata Lenard, and Stoyan J. Mascaro, Martin Melecky, Yigal Menashe, Tenev (All Independent Evaluation Group); Margaret J. Miller, Cedric Mousset, Thomas Axel van Trotsenburg, Lisa Finneran, Stuart Rehermann, Matthew Saal, James Seward, James Stephens, and Anton Dobronogov (all Lin Shi, Susan K. Starnes, and Emile J. M. Development Finance Vice Presidency); Man- Van der Does de Willebois. Data contribu- uela V. Ferro, Theo Thomas, Ashley Taylor, tions were received from Subika Farazi and and Jane Hwang (all Operations Policy and Diego M. Sourrouille. Country Services Vice Presidency); Caren A background research conference was Grown and Tamova Christie (both Gender held jointly with the Federal Reserve Bank of Cross-Cutting Solution Area); Alberto Ninio Chicago, and an edited volume with all con- and Sandie Okoro (both Legal Vice Presi- tributions was produced (Demirgüç-Kunt, dency); and Galina J. Mikhlin-Oliver (Integ- Evanoff, and Kaufman 2016). The individ- rity Vice Presidency). ual chapters of the report were presented at The report would not be possible without Global Financial Development seminars. The the production team, including Patricia Kata- seminars were presented by members of the yama (acquisitions), Aziz Gokdemir (publish- core team and benefited from thorough dis- ing officer), Susan Graham (project manager), cussions from David Michael Gould and Erik Sabra Ledent (copy editor), and Deb Appel- Feyen (chapter 1), Ted Haoquan Chu and Barker and Nora Leah Ridolfi (print coor- Steen Byskov (chapter 2), Mario Guadamillas dinators). Bruno Bonansea was responsible GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 ACKNOWLEDGMENTS xv for maps, and Sheela Na Cao designed the feedback from the World Bank Data Help cover. Roula Yazigi assisted the team with the Desk for the team to enhance the statistics of website. The communications team included the Database. Phil Hay and Ryan Douglas Hahn. Excellent The authors would like to thank the many administrative and budget assistance was pro- country officials and other experts who vided by Tourya Tourougui. William Prince, participated in the surveys underlying this Tariq Afzal Khokhar, Jomo Tariku, Ana Flo- report, including the Financial Development rina Pirlea, and Omar Hadi supported the Barometer. publication of the Global Financial Devel- Financial support from the Knowledge for opment Database and the Financial Devel- Change Program’s research support budget is opment Data Tables, associated with the gratefully acknowledged. report. Ana Florina Pirlea provided valuable Abbreviations and Glossary AML/CFT anti-money laundering and combating the financing of terrorism BCBS Basel Committee on Banking Supervision BIS Bank for International Settlements CBS Consolidated Banking Statistics, BIS CGFS Committee on the Global Financial Systems EAP East Asia and Pacific EBRD European Bank for Reconstruction and Development ECA Europe and Central Asia EU European Union FDI foreign direct investment FSB Financial Stability Board G-20 Group of 20 G-SIB global systematically important bank IC immediate counterparty IFC International Finance Corporation IMF International Monetary Fund LAC Latin America and the Caribbean LBS Locational Banking Statistics, BIS M&A mergers and acquisitions MENA Middle East and North Africa NPL nonperforming loan OECD Organisation for Economic Co-operation and Development ROA return on assets SAR South Asia SME small and medium enterprise SRM Single Resolution Mechanism SSA Sub-Saharan Africa SSM Single Supervisory Mechanism TLAC total loss absorbing capacity UR ultimate risk WTO World Trade Organization Note: All dollar amounts are U.S. dollars ($) unless otherwise indicated. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 xvii xviii A B B R E V I AT I O N S A N D G L O S S A R Y GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 GLOSSARY Country A territorial entity for which statistical data are maintained and pro- vided internationally on a separate and independent basis (not neces- sarily a state as understood by international law and practice). The term, used interchangeably with economy, does not imply political independence or official recognition by the World Bank. Domestic bank A bank restricted to the home country operations, neither owning for- eign subsidiaries nor being owned by any foreign banking entity. Financial Conceptually, a process of reducing the costs of acquiring information, development enforcing contracts, and making transactions. Financial system A country’s financial institutions (banks, insurance companies, and other nonbank financial institutions) and financial markets (such as those in stocks, bonds, and financial derivatives). Also includes the financial infrastructure (for example, credit information–sharing sys- tems and payments and settlement systems). Global bank Conceptually, a bank with significant asset size and an international reach of business. Although there is no single standard definition, in this report global bank refers to a large international bank with activi- ties in multiple regions. Institutional investors Public and private pension funds, life insurance companies, non–life insurance companies, and mutual funds. International bank A bank with significant cross-border operations or international subsidiaries. Nonbank financial Institutional investors and other nonbank financial intermediaries institutions (such as leasing companies and investment banks). Offshore financial A country or jurisdiction providing financial services to nonresidents center beyond a scale commensurate with the size and financing of the domestic economy. Regional bank A bank owning foreign subsidiaries with a focus on a specific host region or set of countries. Overview uccessful international integration, sup- competitive banking systems; and second, S ported by sound national policy and effective international cooperation, has underpinned most experiences of rapid by enabling risk sharing and diversification, thereby smoothing out the effects of domestic shocks (Claessens, Demirgüç-Kunt, and Huiz- growth, shared prosperity, and reduced pov- inga 2001; Cull and Martínez Pería 2010; erty. Perhaps no sector than banking better il- Goldberg, Dages, and Kinney 2000). Depend- lustrates both the potential benefits and perils ing on the conditions, however, international of deeper international integration. Interna- banking may also lead to costs. Risk sharing tional banks—banks that do business outside will inevitably expose host countries to sys- the country where they are headquartered— temic risks from time to time; and more re- are often considered important contributors cently, international banks have been criticized to sustainable financial development, by pro- for playing a role in the transmission of shocks moting economic growth. The decade before across borders during the global financial cri- the 2007–09 global financial crisis was char- sis (De Haas and van Lelyveld 2014). Cross- acterized by a significant increase in finan- border bank flows also play a crucial role in cial globalization, particularly for banking transmitting global liquidity to local financial institutions, which coincided with increases systems, and international banking may pro- in bank size to unprecedented levels (Claes- mote destabilizing boom-bust cycles in poor sens 2016; Demirgüç-Kunt, Evanoff, and institutional environments (Borio, McCauley, Kaufman 2016). These changes were mani- and McGuire 2011; Bruno and Shin 2015a). fested in both a rise in cross-border lending In the wake of the global financial crisis, and a growing participation of foreign banks the globalization trend has been partially re- around the world as they became an integral versed, as multinational banks from devel- part of financial systems, especially in devel- oped countries—“the North”—have scaled oping countries. back their international operations, coincid- International banking activities may con- ing with a general backlash against globaliza- tribute to faster growth, greater welfare, and tion. While banks based in high-income coun- enduring stability in two important ways: first, tries drove exits, developing country banks by bringing much-needed capital, expertise, continued their international expansion, and new technologies, thereby leading to more accounting for the bulk of new entry into GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 1 2 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 foreign markets. Cross-border bank claims to contribute to this debate on the benefits and syndicated loans also saw significant and costs of international banks and provide retrenchments, but “South–South” transac- evidence-based policy advice. The report ex- tions—from developing countries to other de- amines both new and existing evidence on the veloping countries—started growing, starting activities of international banks, focusing on to replace the leading role of “North–South” their international brick-and-mortar opera- transactions in the aftermath of the global tions as well as their cross-border activities, financial crisis. This greater South–South ac- and their drivers and economic effects. Over- tivity has also coincided with regionalization, all, the report sifts through research evidence both in the roster of foreign banks in many to shed light on the following long-standing host countries and in cross-border flows. policy concerns: To what extent should devel- The full causes and implications of these oping countries trust international banks with changes are not yet completely understood. the local provision of their financial services, Postcrisis supervisory and regulatory reforms given that they may retrench and lead to a sig- intended to enhance bank balance sheets and nificant erosion of skills and services due to financial stability, such as more stringent pressures from their home countries? Should capital requirements for banks and macro- developing country authorities be especially prudential regulations, have been at least par- cautious in their approach to admitting tially responsible for these changes, affecting South–South international banking activities? the supply of credit. During the crisis, banks Is a lack of experience or insufficient home also reduced lending as demand for external country prudential regulation and supervision financing abroad declined, and sovereign and a concern, or is it offset by the region-specific other risks increased. In addition, the crisis knowledge that gives these banks a better po- highlighted the need for greater cooperation tential to provide banking services in develop- in resolving troubled banks with multina- ing countries? Does allowing foreign banks to tional operations and a more explicit ex ante have a larger market share risk reducing ac- understanding of the associated burden shar- cess to and increasing the price of banking ser- ing. More generally, the regionalization of in- vices for small and medium-sized enterprises ternational banking is prompting countries to (SMEs) and lower-income households? Fi- contemplate regional regulatory and supervi- nally, how is technology—especially financial- sory approaches. technology (fintech) firms that work globally Given these developments, international and across borders through digital products— banking has attracted heightened interest from likely to influence international banking? The policy makers, researchers, and other financial report provides a synthesis of what we know, sector stakeholders. The global financial crisis as well as areas where more evidence is still has certainly led to a reevaluation of the po- needed and recent developments that raise tential benefits and costs of bank globalization many new questions. Box O.1 provides the because many observers perceive global banks main messages. to have been mainly responsible for the trans- Policy makers and other financial sector mission of shocks across borders during the practitioners are divided on policies toward recent financial crisis (Demirgüç-Kunt, Eva- foreign bank entry. According to the fourth noff, and Kaufman 2016). Concerns about Financial Development Barometer—an infor- the effects of international banking—in par- mal poll of policymakers in developing coun- ticular, global systemically important banks tries undertaken for this Global Financial (G-SIBs), which are deemed to be too big and Development Report; see box O.2—respon- interconnected to fail—have been voiced by dents recognize both positive and negative the Financial Stability Board (FSB), the G-20, effects of foreign banks. Although foreign and policy makers around the world. banks are credited with providing financial The Global Financial Development Report services to firms and households and with in- 2017/2018: Bankers without Borders seeks troducing new ways of improving access to GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 3 BOX O.1 Main Messages of This Report Following a decade of increased globalization, There is an important role for policy in maximiz- international banking suffered a setback after the ing international banking’s benefits and minimizing global fi nancial crisis. There have been large reduc- its costs. International banking can have important tions in cross-border flows, and less foreign bank benefits for development by improving efficiency and entry. The trends in foreign bank entry differ across risk sharing, but benefits do not accrue unless the countries, however. While developed country banks institutional environment is developed and the right retrenched, developing country banks continued to policies are adopted. Research suggests that institu- invest abroad, both through cross-border and brick- tionally better developed countries tend to reap both and-mortar operations, leading to a more regional- more of the development and risk-sharing benefits of ized banking system with greater South–South pres- international banking. Specifically, good information ence. Hence, international bank lending remains an sharing, property rights, contract enforcement, and important source of fi nance for developing countries, strong regulation and supervision are key. Of par- although its composition has changed since the crisis. ticular importance, these improvements prevent for- And although regulatory barriers to foreign banking eign banks from just displacing domestic banks and increased over this period, large international banks exploiting regulatory weaknesses. And with strong continued to become larger. institutions, both the foreign banks and domestic Remaining open despite rising protectionism is banks that are now exposed to greater competition important for countries to continue to benefit from can go downmarket and improve access and inclu- global flows of funds, knowledge, and opportunity. sion for small and medium-sized enterprises (SMEs) International banking activities have the potential and households that were previously excluded. to improve the degree of competition in the local Recent research suggests that for designing effec- banking sector, help upgrade skills, and improve the tive policies, it is important to keep in mind differ- efficiency of resource allocation. Risks can be shared ences in bank characteristics and home and host and diversified. Through the threat of exit, interna- country conditions. For development considerations, tional banking can also discipline domestic fi nan- larger banks and those that are culturally closer, cial policies, regulations, and supervisory practices with a greater share of domestic fi nancial intermedia- and can weaken the political entrenchment between tion including deposit taking, tend to provide better domestic financial institutions and governments. access to SMEs and households and are less likely to Overall, more capital and increased efficiency of focus only on large corporate customers. As for sta- allocation will promote faster economic development bility, the risk-sharing benefits of globalization need and greater fi nancial stability. to be considered over the long term. Cross-border However, international banking is no panacea flows tend to be more volatile and less resilient than a for guaranteeing fi nancial development and stabil- brick-and-mortar bank presence. Foreign banks with ity. Openness also introduces more volatility and a greater commitment, as reflected in closeness both exposes countries to foreign exchange risks, foreign in distance to headquarters and in culture, that have monetary policy shocks, and other mismatches. In larger local market shares, and rely more heavily on weak institutional environments with poor informa- local funding, are more willing both to incur tempo- tion, inadequate contract enforcement, and weak rary costs when faced with external shocks and to regulation and supervision, global fi nance may lead support the local economy. to destabilizing boom-bust cycles; and competition It is challenging to encourage the right type of for- from foreign banks may drive out domestic banks eign bank presence or forms of capital flows without and reduce access to fi nance and inclusion. More- causing distortions. Many supervisory agencies no over, risk sharing also has a downside. International longer rely on the home supervisor of their local affil- banks that export risks will also import them. And iates for ensuring stability. Compared with branches, international banking can magnify distortions in foreign subsidiaries can be self-sufficient—with domestic bank policy, regulation, and safety nets. high capitalization requirements and a high share (box continued next page) 4 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX O.1 Main Messages of This Report (continued) of funding through retail deposits—which therefore possible risks. Greater South–South banking is likely improves stability. Among subsidiaries, a mix of to increase local competition and fi nancial develop- new, greenfield entrants and takeovers or mergers of ment, as any other entry would. But to the extent existing domestic banks by foreign banks may also that banks from the South are more familiar with help diversify risks. Research has found that foreign the institutions and the culture of other developing bank entry has a stronger positive effect on compe- countries, they tend to be better at serving smaller tition with greenfi eld investments than with merg- and more informationally opaque segments, such ers and acquisitions, though greenfield investments as SMEs and households. They are also likely to be are not necessarily associated with greater access to more committed to host countries and less likely to fi nancial services. Better integrated with the parent exit during downturns. However, to the extent that bank, greenfi elds may also help more during local shocks are more correlated within regions than glob- downturns; however, investment through acquisi- ally, greater regionalization will limit risk sharing tions may yield greater benefits in response to home and the diffusion of the best banking technology country or global shocks. In addition, to the extent and skills. Greater South–South banking also entails possible, host economies can opt—for example, dur- additional risks from having foreign banks from less- ing privatization—to allow foreign banks from home regulated and institutionally weaker home countries. countries with stricter bank regulations, or to diver- The net effect of regionalization is not clear a priori sify foreign banks by their home country to mitigate and is a topic for further research. Questions remain the impact of foreign shocks from a specific country. about whether there is an optimal mix of foreign For many countries, however, options to shape for- entry through global and regional banks in order eign entry may be more circumscribed, depending on to maximize the benefits and minimize the costs of their obligations under multilateral and preferential bank internationalization. services trade agreements. After the crisis, there was also a disintermediation The regulation and supervision of international trend, whereby cross-border bank credit was substi- banking are complex, and should involve extensive tuted with capital market funding. The importance of cross-border coordination. There is a need for more well-functioning domestic capital markets as a “spare intensive cooperation between home and host coun- tire” was confi rmed during the global fi nancial cri- tries, going beyond memorandums of understanding sis, when in many countries they substituted at least and information exchanges. This need refl ects the partially for the decline in bank funding. The pat- limited ability of host country authorities to super- terns illustrated here highlight not only the benefits vise appropriately larger international banks, along of having alternative sources of fi nance but also the with the distorted incentives of both home and host need to broaden the policy discussion to consider the country supervisors who do not consider the effects financial system as a whole, and not focus just on one of their decisions beyond their borders. Ideally, coor- type of fi nancial intermediary such as global banks. dination should include an international agreement These shifts do not alleviate the funding constraints on crisis management that explicitly outlines respon- of smaller fi rms without access to markets, however. sibilities and processes to follow in case of a resolu- For smaller fi rms with limited or no access to capital tion. With the changing composition of the industry markets, the important role of banks remains. and the increased role of technology, coordinating Fintech developments may have important impli- regulation and supervision remains a major chal- cations for the global banking landscape. Fintech lenge for policy makers. And because this is very fi rms are rapidly expanding and speeding up trans- much an ongoing agenda, a more in-depth analysis of actions at a lower cost, and developing technologies regulatory reform will be included in a future Global for data security, risk management, mobile banking Financial Development Report. and alternative currencies. Large foreign banks that The rise of South–South banking and banking’s can devote more resources to research and devel- greater regionalization come with benefits but also opment are likely to play an important role in this (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 5 BOX O.1 Main Messages of This Report (continued) area. So far, the relationship between global banks complex supervision and regulation of foreign banks. and fi ntech fi rms has been mostly complementary, Regulators need to keep pace with the rapid entry of with incumbent fi rms pouring investment into the new, nonbank providers into the market and of the fi ntech sector. The trend toward digitalization and rapid rolling out of digital services. And they need to technological innovation will likely increase the pay attention to the potential risks that these changes role of nonphysical distribution channels. Fintech may entail—such as the protection of vulnerable cus- also comes with risks; hence, regulators are paying tomers, discrimination, disclosure requirements for close attention to it and to how it is revolutionizing SMEs, and privacy concerns related to the sharing of the sector, bringing new challenges to the already- consumer data. finance, there are also concerns about stabil- Given the trade-offs facing policy makers, ity and the “cherry picking” of best clients. it is crucial to thoroughly examine the costs Financial market practitioners and policy and benefits of international banking and makers also note that international banks to devise effective policies based on the evi- may have become too large and complex, dence. Global Financial Development Report with only half the respondents indicating 2017/2018: Bankers without Borders seeks confidence that their national policy frame- to bring new data and research and to draw works are sufficient to address the potential on available insights and experience to con- stability risks posed by these institutions. tribute to this discussion. BOX O.2 Views on International Banking by Practitioners: Global Financial Development Barometer To examine views on international banking among Of the 222 individuals polled, 112 (50 percent) from the World Bank group’s clients, the Global Financial 9 developed and 42 developing countries responded Development Report team undertook new rounds to the survey. of the Financial Development Barometer in 2015 More than 70 percent of the participants perceive and 2016. The barometer is an informal global poll international banking to play an important role in of fi nancial sector practitioners focusing on devel- providing fi nancial services to fi rms, and to a lesser opment issues. This poll examines trends and sen- extent in serving households (see figure BO.2.1). timents regarding financial sector issues that are More than two-thirds of the respondents acknowl- under policy debate. The latest barometer explored edge the novel ways international banks introduce the perceived drivers and effects of international products to improve fi nancial access. Nevertheless, banking as well as the effi cacy of regulatory poli- more than 80 percent of respondents are concerned cies designed in the aftermath of the global fi nan- that foreign banks may be aggressive in cherry pick- cial crisis. It reveals interesting insights from central ing the most profitable and established borrowers. bankers, fi nance ministry officials, regulatory/super- Also, more than 70 percent of respondents agree that visory authorities, market participants, and practi- international banks contribute to the transmission of tioners at various international fi nancial institutions. international shocks. The perceptions of global and (box continued next page) 6 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX O.2 Views on International Banking by Practitioners: Global Financial Development Barometer (continued) FIGURE BO.2.1 The Impact of Global and Regional Banking Play an important role in providing financial services to firms 72 79 Play an important role in providing financial services to households 51 67 Introduce new ways of improving financial access for firms and households 62 75 75 Contribute to international shock transmissions 70 89 Choose the most profitable and established borrowers 80 0 20 40 60 80 100 Share of respondents who agree (%) Global banks Regional banks Source: Financial Development Barometer. regional banks vary, because regional banks are seen to home and host country jurisdictions (see table as having stronger political and cultural links to the BO.2.1). Views differ quite a bit on whether exist- host country. Hence, positive effects are more com- ing national policy frameworks will be sufficient to monly associated with regional banks and negative address such risks in light of the crisis experience, effects with global banks. where respondents are roughly split in the middle. An overwhelming proportion of survey partici- The widespread stability concerns are also reflected pants sees global banks as having become unwieldy in strong support for regulatory interventions to and complex, potentially posing stability risks address such risks. TABLE BO.2.1 Selected Results from the Financial Development Barometer Percentage of respondents agreeing with the statements In your view… “. . . global banks have become excessively complex.” 93 “. . . global banks have become too large from an operational efficiency viewpoint.” 86 “. . . global banks could pose excessive stability risks to their home (host) country.” 89 (89) “. . . existing national policy frameworks would be sufficient to address such stability risks.” 54 “. . . the global reform agenda should be complemented by reforms of banking structures (separation of bank activities) to effectively address the risks posed by global, cross-border banks and reduce their complexity.” 92 “. . . in your country, macroprudential policies should be relied on to mitigate the risks of crises and their related cost associated with the activities of global banks.” 85 Source: Financial Development Barometer. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 7 INTERNATIONAL BANKING: FIGURE O.1 Cross-Border and Local Claims by Foreign Banks, MEASUREMENT AND RECENT 2005–15 TRENDS 40 International banks are involved in two main types of international activities: cross-border 35 flows, and foreign participation in domestic 30 banking systems through brick-and-mortar 25 operations. Trade in financial services most % of GDP commonly takes place through (1) cross- 20 border operations of a bank, in lending, de- 15 posit taking, or insurance; and (2) provision of these services through a foreign bank’s 10 presence, which can take the form of a sub- 5 sidiary or a branch in a foreign country. Here, 0 an international bank is defined as a bank 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 with cross-border activities or foreign subsid- Developing, cross-border Developing, local iaries or branches, or both. A global bank is High-income, cross-border High-income, local defined as an international bank with opera- tions in multiple regions. Regional banks are Source: Consolidated Banking Statistics (Ultimate Risk Basis), Bank for International Settlements. Note: Figures are country-level averages by income level of the borrowing countries over the defined as banks that focus their operations period 2005–15. Borrowing countries are categorized as high-income and developing countries in a specific region. And a domestic bank is according to the World Bank’s country classifications as of 2017. Cross-border claims refer to those extended by foreign bank offices outside the borrower’s jurisdiction. Local claims refer to defined as a bank that does not have interna- those extended by foreign bank offices within the borrower’s jurisdiction. Total ratios of outstand- tional operations. ing values to gross domestic product are provided in each case. The decade before the financial crisis saw significant increases in international banking activities, a trend that coincided with general negative since 2010 (see figure O.2). Although globalization during this period, including the number of foreign banks exiting markets trade and foreign direct investment (FDI) in remained more or less the same, there was goods and services. Deregulation and liber- much less entry after the crisis. The number alization across the world also promoted in- of foreign banks worldwide has declined, but creases in cross-border activities, as well as not relative to the number of domestic banks, local bank presence. Hence, both types of which saw an even greater decline. More im- activities displayed an increasing trend just portant, banks based in high-income coun- before the global financial crisis hit in 2008, tries drove the exits, but developing coun- yet declined afterward (figure O.1).1 Devel- tries continued their foreign bank expansion, oping countries experienced a shorter-lived accounting for close to 60 percent of new decline than developed countries, particu- entries. Hence, two important trends have larly in foreign brick-and-mortar presence. emerged: South–South banking, and regional- It is particularly important that the volume ization. By 2013, banks based in high-income of foreign bank claims via local lending now countries still represented 89 percent of for- exceeds that of cross-border lending in devel- eign bank assets globally, but this share was oped countries and is comparable in develop- 6 percentage points lower than before the cri- ing countries, because lending by brick-and- sis, representing a greater diversity of foreign mortar banks has proven to be more resilient bank ownership. Foreign bank presence also in response to the financial crisis. became more regionally concentrated, with Local lending was more resilient than the average intraregional share increasing cross-border flows after the global financial by 4 percentage points. This largely reflected crisis, but net foreign bank entry has become the expansion of developing country banks 8 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FIGURE O.2 Number of Entries and Exits of Foreign Banks, and Central Asia (ECA), the Middle East and 1995–2013 North Africa (MENA), and Sub-Saharan Africa (SSA), it has continued to increase in 120 East Asia and the Pacific (EAP) and Latin America and the Caribbean (LAC) (see fig- 80 ure O.3). High-income countries also saw a decline. Nevertheless, despite these develop- ments, foreign banks continue to constitute 40 40–60 percent of the banking industry in the Numbers ECA, LAC, and SSA regions. Hence, lending 0 by international banks remains an important source of finance, particularly in these regions. –40 Despite the overall drop in cross-border flows since the global financial crisis, devel- –80 oping countries have increased their role as providers of cross-border funds to other de- 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20 veloping countries. The share of Southern Entry Exit Net entry economies in cross-border bank credit chan- neled to the South has almost doubled since Source: Foreign Bank Ownership Database (Claessen and van Horen 2015). 2007, to 8.5 percent in 2014. The same pat- tern can be observed for syndicated loans, into space opened up by the retrenchment of where South–South shares have grown from global banks. 3.5 percent before the crisis to 7.7 percent These aggregate trends hide important dif- since it (figure O.4). Although most devel- ferences across different regions. Since the oping countries have expanded their bank crisis, while the share of foreign bank assets credit toward Southern economies after the in total banking assets has declined in Europe crisis, the EAP region accounts for the bulk FIGURE O.3 Share of Foreign Bank Assets, by Region, 2005–13 70 60 50 % of total bank assets 40 30 20 10 0 East Asia Europe and Latin America Middle East South Asia Sub-Saharan High-income and Pacific Central Asia and the and Africa OECD Caribbean North Africa 2005 2009 2013 Source: Calculations based on Foreign Bank Ownership Database (Claessens and van Horen 2015). Note: Regions exclude high-income countries that belong to the Organisation for Economic Co-operation and Development (OECD). GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 9 FIGURE O.4 Direction of Cross-Border Bank of South–South transactions. Specifically, on Lending, before and after the Global Financial average, EAP originated 25 percent of the Crisis total cross-border syndicated loans to devel- oping countries during the postcrisis period, 100 4 8 4 8 up from 12 percent during the precrisis aver- 5 10 10 8 age. An important part of the expansion in 80 9 17 South–South bank credit since the crisis has 14 17 been associated with a trend toward regional- 60 ization—with Brazil, China, India, and South Percent Africa playing an increasingly important role in their regions. In particular, intraregional 40 76 74 syndicated lending accounted on average for 68 68 75 percent of South–South syndicated lending 20 during the 2010–14 period, up from 70 per- cent during the 2003–07 period. This pattern 0 held across most regions, except for LAC and 2007 2014 2003–07 2010–14 Cross-border Cross-border syndicated MENA (Broner and others 2017). bank claims loan flows The rise of South–South brick-and-mortar North–North North–South South–North South–South banking since the crisis has also varied across regions. As in the case of cross-border activi- Source: Broner and others 2017. ties, the increase in South–South brick-and- Note: This figure shows the value of the stocks (flows) of cross-border bank claims (syndicated loans) scaled by worldwide bank claims (syn- mortar banking operations and regionalization dicated loans). Data are aggregated for all economies within a source since the global financial crisis has been more region to all economies within a receiver region. For cross-border bank claims, the end-of-year statistics are shown. For syndicated loans, the prominent in some regions than others (figure statistics are calculated year by year and then averaged over time. O.5). Specifically, a greater share of foreign The North includes the G-7 economies and 15 other Western European economies. The South includes the remaining economies not included in banks in the MENA and SSA regions are now the North. Offshore financial centers are excluded from the sample. regional banks compared with precrisis years. FIGURE O.5 Share of Regional Foreign Banks among Foreign Banks, Country-Level Averages, 1997–2013 70 60 50 % of foreign banks 40 30 20 10 0 East Asia Europe and Latin America Middle East South Asia Sub-Saharan Africa and Pacific Central Asia and the Caribbean and North Africa 1997 2001 2005 2009 2013 Source: Calculations based on Foreign Bank Ownership Database (Claessens and van Horen 2015). Note: Regions exclude high-income countries that belong to the Organisation for Economic Co-operation and Development (OECD). 10 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FIGURE O.6 Trends in Bank Size 160 140 120 100 % of GDP 80 60 40 20 0 East Asia Europe and Latin America Middle East South Asia Sub-Saharan High-income and Pacific Central Asia and the and Africa OECD Caribbean North Africa 2005 2008 2011 2014 Source: Bureau van Dijk Bankscope (database). Note: Values represent regional country-level averages of combined assets of the top five banks relative to GDP, for the period 2005–14. Another trend in bank internationalization FIGURE O.7 Share of Developing Countries is a dramatic increase in bank size. From 2005 with Restrictions on Foreign Bank Entry through Alternative Modes to 2014, the total asset size of the world’s largest banks increased by more than 40 per- cent. Despite regulatory efforts after the crisis 35 to address too-big-to-fail issues, bank size has 30 not shrunk in either absolute terms or—as seen in figure O.6—relative to gross domestic 25 product (GDP). The largest banks are also the ones that are active at the international level. 20 Percent Finally, since 2007, with the backlash 15 against globalization, many countries, includ- ing many developing countries, have adopted 10 increasingly restrictive policies toward foreign banking. These policies take the form of direct 5 restrictions (see figure O.7) or indirect poli- 0 cies affecting foreign bank presence—such as Acquisition Subsidiary Branch Joint venture macroprudential policies affecting foreign 2000 2003 2007 2011 bank operations (see figure O.8), countercycli- cal buffers, or even ring fencing—in an effort Source: World Bank Regulation and Supervision (database). Note: The analysis includes 78 developing countries providing complete to regulate capital flows. All in all, restrictions responses to relevant questions in the 2003, 2007, and 2011 survey on international banking activities increased waves of the Banking Regulation and Supervision Surveys. after the global financial crisis, coinciding with the reduction in cross-border flows and net entries. financial crisis. There have been large re- In summary, following a decade of in- ductions in cross-border flows, and fewer creased globalization, international bank- foreign bank entries. The trends in foreign ing has suffered a setback since the global bank entry differ across countries, however. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 11 FIGURE O.8 Share of Home and Host Countries technologies. Pressures from foreign capital That Tightened Macroprudential Policies, 2005–13 may discipline countries’ macroeconomic and financial management, and the entry of for- 100 eign institutions may help improve regulation and supervision, as well as possibly breaking Share of countries with policy tightening (%) 80 the political entrenchment between domestic 86 financial institutions and governments. All in all, more capital and increased efficiency of 60 allocation will promote faster economic de- 58 56 velopment and greater financial stability, be- 40 44 cause risks can be exported and shared more efficiently (Cetorelli and Goldberg 2012b; 20 Claessens, Demirgüç-Kunt, and Huizinga 2001; De Haas and van Lelyveld 2010; Goldberg 2009). However, openness also 0 Home Host Home Host comes with its own risks, exposing the coun- countries countries countries countries tries to foreign risks, foreign monetary pol- High-income countries Developing countries icy shocks, and other types of mismatches (Morais and others, forthcoming). Rapid Sources: Claessens and van Horen 2015; Cerutti, Claessens, and Laeven growth in international credit may more easily 2015. Note: Countries are defined as home countries when they own more lead to boom-bust cycles in poor institutional banks in other countries than the number foreign subsidiaries they host environments (Borio, McCauley, and McGuire and as host countries if they host more foreign subsidiaries than the banks they own abroad. 2011). When international banks focus on prime customers and increase competition, poor information and contract enforcement While developed country banks retrenched, may make it difficult for domestic banks to developing country banks continued to in- move to other segments and serve previously vest abroad, through both cross-border and underserved clients. This can reduce the fran- brick-and-mortar operations, leading to a chise values of domestic banks, and possibly more regionalized banking system with a have a negative impact on access and inclu- greater South–South presence. Large interna- sion by driving them out altogether. Also, risk tional banks continued to become larger. Dur- sharing inevitably implies that systemic risks ing this period, regulatory barriers to foreign in source countries may be imported from banking have also increased. time to time (Peek and Rosengren 1997, 2000; Schnabl 2012). Moreover, existing policy dis- tortions in domestic systems—such as poorly WHY DO WE CARE ABOUT designed safety nets, and weak regulation and INTERNATIONAL BANKING?: supervision that generate excessive risk-tak- FINANCIAL DEVELOPMENT, ing incentives—tend to be magnified through STABILITY TRADE-OFFS, international banking that expands risk- AND THE ROLE OF POLICY taking opportunities (Demirgüç-Kunt, Kane, Financial globalization comes with both op- and Laeven 2014). portunities and risks. Possible benefits include Bank internationalization, on its own, is a globally more efficient allocation of capital no panacea for guaranteeing financial devel- and enhanced risk sharing. A liberalized capi- opment and stability. International banking tal account promotes external financing, and can have important benefits for development increased competition due to foreign entry is by improving efficiency and risk sharing, but likely to improve efficiency and domestic re- these benefits will not accrue unless the institu- source allocation. Better know-how and finan- tional environment is developed and the right cial skills are imported, as well as specialized policies are adopted (Detragiache, Tressel, and 12 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Gupta 2008; Gormley 2014; Mian 2006). of capital flows and foreign bank presence Thus, the challenge for policy makers is to matter (Claessens 2016). Some flows, such as provide an environment that will maximize bank FDI in the form of brick-and-mortar op- the benefits of internationalization while mini- erations, tend to be associated with the diffu- mizing the costs. Research suggests that insti- sion of technology and know-how compared tutionally better developed countries tend to with cross-border flows. Larger foreign banks reap both more of the development and risk- and those that are culturally closer, with a sharing benefits of international banking. greater share of domestic financial interme- Therefore, it is important for countries to diation, including deposit taking, tend to pro- ensure that they have the right regulations vide better access to SMEs and households and infrastructure in place. Although for- and are less likely to engage in cherry picking eign bank participation may help to break (Berger and Udell 2006). or mitigate the political entrenchment of in- For stability considerations, it is important cumbent banks, even in a bad institutional to recognize that risk sharing also has a down- environment, those foreign banks may just side. International banks that export risks will replace incumbents and continue collecting also import them. Hence, the net risk-sharing profits and exploiting regulatory weaknesses benefits of globalization need to be considered without necessarily improving the competi- over the long term. Again, the heterogeneity tiveness and efficiency of the banking sector of flows and types of institutions and inves- (Detragiache, Tressel, and Gupta 2008; On- tors matter (Claessens 2016). Short-term, gena, Popov, and Udell 2013). Thus, finan- cross-border flows tend to be more volatile cial liberalization should be accompanied by and less resilient than a brick-and-mortar institutional reforms and may be introduced bank presence. And some investors, such as gradually, ensuring competitiveness in the international banks and mutual funds, are af- banking industry to avoid foreign banks com- fected by global financial and monetary con- pletely crowding out domestic banks. Having ditions to a greater extent, exposing countries a host country with good institutions and a to more volatility. Although these can be miti- competitive banking industry will also help gated, they cannot be fully eliminated without foreign banks become core operations for giving up openness altogether. Nevertheless, their parent banks—which could reduce their research suggests that banks with a greater incentives to retrench during home country commitment, as reflected in closeness both in or global downturns. Other institutional fac- distance to headquarters and in culture, that tors—such as the information environment have larger local market shares and a greater and the quality of contract enforcement—are reliance on local funding, are more willing to also crucial for foreign banks to benefit host incur temporary costs when faced with exter- economies by expanding their services more nal shocks and to support the local economy widely beyond their niche customers, improv- (Claessens and van Horen 2014a). ing access and inclusion. Furthermore, when Encouraging the right type of foreign bank accompanied by improved information shar- presence or forms of capital flows without ing—through credit registries, for example— causing distortions is challenging. Many su- foreign banks can help to lower average lend- pervisory agencies no longer rely on the home ing interest rates and increase average loan supervisor of the local affiliates for ensuring quality (Bruno and Hauswald 2013; Claes- stability. Compared with branches, foreign sens, Hassib, and van Horen 2014). subsidiaries can be self-sufficient—with high The key to designing effective policies is to capitalization requirements and a high share recognize that the benefits and costs of inter- of funding through retail deposits—thereby nationalization vary depending on bank char- improving stability. Among subsidiaries, a acteristics and the conditions in the home and mix of new and greenfield units and takeovers host countries. It is particularly important or mergers may also help diversify risks. Re- that differences in origins, types, and forms search has found that foreign bank entry has GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 13 stronger positive effects on the competition latter approach (Claessens 2016). Ring fenc- with greenfield investments than with merg- ing is a local regulator’s reaction to limit the ers and acquisitions, though greenfield in- potentially negative consequences of having vestments are not necessarily associated with foreign banks. Host authorities request local greater access to financial services (Claeys and liquidity and capital to minimize the impact Hainz 2014; Delis, Kokas, and Ongena 2014; of external shocks. In terms of advantages, Jeon, Olivero, and Wu 2011). By being better this approach provides better incentives for integrated with the parent bank, greenfields local supervision and no burden sharing re- may also help more during local downturns; quirements. Ring fencing, however, is also however, investment through acquisitions less efficient for financial institutions, because may yield greater benefits in response to home it lessens the benefits of cross-border bank- country or global shocks (Jeon, Olivero, and ing in the first place, reducing the scope for Wu 2013). Finally, some diversification of for- risk sharing and potentially imposing costs eign banks’ business models may be desirable in times of stress through possible runs and in shielding host economies from the negative liquidity problems. This approach also under- outcomes associated with a specific type of mines the incentives for cross-border regula- activity (for example, in response to a nega- tion and supervision, thus impairing the gen- tive shock to fee-based, non-interest-income- eral openness of financial systems. Although generating activities, or being overly reliant these two approaches may be too extreme for on wholesale funding, which could dry up many countries, an intermediate model of co- during global downturns). When possible— operation that includes some elements of the as in a privatization—host country authorities universal approach may be feasible. Ideally, could also try to diversify the roster of home this intermediate model could adopt an inter- countries and to make sure that the prospec- national agreement on crisis management that tive parent banks are also diversified, so that explicitly outlines responsibilities and pro- they can provide liquidity and other support cesses to follow in case of a resolution (Beck to their subsidiaries, even when they face and Wagner 2016). Overall, despite progress shocks at home. Research shows that effec- since the financial crisis, the global regulatory tive home country regulations, proximity to reform agenda is at a crossroads; many as- the home country—cultural or physical—and pects remain unfinished, and the finalization a core position in the banking group lower of the Basel III reform package appears to the probability of exit in response to shocks have been delayed. Hence, more comprehen- (Claessens and van Horen 2014b). For many sive coverage of this topic will be included in countries, however, options to shape foreign a future issue of this report, when policy mak- entry may be more circumscribed, depending ing is more advanced and additional data and on their obligations under multilateral and research are available. preferential service trade agreements. Within this broader context, this overview The regulatory and supervisory failures concludes with a discussion of three focus ar- during the recent global financial crisis led eas that are important in international bank- to an intense effort to redesign the regula- ing and their policy implications: the rise of tory landscape, which is still ongoing. Two South–South banking, the shift toward alter- extreme approaches influencing the ongoing native sources of funding, and the emergence policy discussions entail territoriality—that of fintech. The focus on these areas reflects is, the ring fencing of activities under a par- the importance of these new trends for policy, ticular authority’s domain, which inhibits because they all present challenges and oppor- an open financial system—and universalism, tunities. These are also areas where research which entails an equitable distribution of is new and limited, and recent developments bankruptcy costs involving cross-border bur- raise many more questions for the future. For den sharing. The European Single Resolution help in navigating the rest of the report, see Mechanism is a prospective example of the box O.3. 14 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX O.3 Navigating This Report The rest of the report consists of three chapters that evidence on the significance, drivers, and impact of cover the benefits and costs of international bank- cross-border bank flows. It focuses on three impor- ing, key facts, and general guidelines for the role of tant developments that are shaping international policy. Within these broader topic areas, the report banking: the role of the South, the substitution of focuses on policy-relevant new developments where fi nancing across markets, and the rise of fi ntech. The new evidence is emerging yet also raises many more chapter discusses these new trends and how they may questions for the future. shape the future global banking landscape, and it Chapter 1 defines international banking and draws out policy implications. presents a conceptual framework for evaluating the There are two statistical appendixes. Appendix benefits and costs associated with globalization. It A presents basic country-by-country data on fi nan- offers stylized facts about the importance of interna- cial system characteristics around the world. It also tional banking across countries and over time, and presents averages of the same indicators for peer highlights recent trends. The chapter also discusses groups of countries, together with summary maps. the advantages and disadvantages of various data It is an update of information from the 2015/2016 sources, which help differentiate between cross-bor- Global Financial Development Report. Appendix B der lending and the brick-and-mortar operations of provides additional country-by-country information international banks. on key aspects of international banking around the Chapter 2 examines the brick-and-mortar opera- world. tions of international banks. It discusses and pro- The accompanying website (http://www.worldbank vides evidence on the determinants of foreign bank .org/financialdevelopment) contains a wealth of entry and its impact on bank competition, efficiency, underlying research; additional evidence, including access to fi nance, and fi nancial stability. Implications country examples; and extensive databases on fi nan- for South–South banking and regionalization are cial development—providing users with interactive discussed, as well as where fi ntech is influencing the access to information on financial systems. Users financial sector. The current global regulatory reform can provide feedback on the report, participate in an agenda is discussed, with alternative approaches to online version of the Financial Development Baro- regulation and supervision. The chapter provides meter, and submit their suggestions for future issues policy guidance on maximizing the benefits of for- of the report. The website also presents an updated eign entry and minimizing its costs. and expanded version of the Global Financial Devel- Chapter 3 mirrors the preceding chapter but opment Database, a data set of more than 70 fi nan- focuses on the cross-border activities of interna- cial system characteristics for 203 economies since tional banks. It discusses recent trends and presents 1960. FOCUS AREA 1: THE RISE OF of developing countries in global financial SOUTH–SOUTH BANKING transactions has allowed these economies to not only diversify their investments but also One of the important recent trends in inter- obtain financing from abroad, complement- national banking has been the rise of South– ing domestic markets and widening their South banking. As the stylized facts in the available funding choices. Greater South– previous section illustrate, developing coun- South banking is likely to increase local com- tries have become more prominent in inter- petition and financial development, as with national banking, and these activities have any foreign entry. But the recent trends in become more regionalized. Research in this South–South banking are also likely to influ- area has been scarce, however, and its policy ence who gets credit and whether it helps im- implications are not well understood. prove access to financial services. Relative to South–South banking may be associated a bank from the North, South–South banks with better access. The increasing participation invest in countries within their region and GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 15 tend to be more familiar with the cultural, lin- FIGURE O.9 Change in Bank Lending Associated with a 1 Percent guistic, legal, and institutional environment of Increase in Growth in GDP per Capita the host country and may be better at collect- ing and processing soft information that al- 2.0 lows them to overcome the common chal- lenges that foreign banks face when lending downmarket to smaller and more informa- 1.5 1.5 tionally opaque segments, especially SMEs and households (Claessens and van Horen Percent 1.0 2014b; Mian 2006). A recent study using firm-level data also finds that a foreign bank 0.9 presence is more strongly linked to higher 0.5 rates of business formation when those banks 0.6 are headquartered in the South (Alfaro, Beck, 0.3 and Calomiris 2015). 0 However, regionalization may also have High-income High-income Developing Developing country, domestic country, country, country, costs. If foreign entry is more regionalized, banks international domestic international this may constrain both the adoption of glob- banks banks banks ally best banking technology and skills across Source: Bertay, Demirgüç-Kunt, and Huizinga 2017. countries and the most efficient allocation Note: The figure shows marginal effects from a regression of bank lending on GDP per capita of capital. Increasing regionalization in the growth and a number of control variables and bank fixed effects, estimated using a sample of 2,750 banks based in 112 countries (47 high-income, and 65 developing) for the period 2000–15. South also limits risk sharing and implies a International bank values are evaluated at the average level of internationalization; that is, the log larger exposure of an economy to shocks of the number of countries in which the international bank is active. The coefficients are signifi- cant at the 10 percent level or better. originating within the region. Recent research has constructed an exten- sive, bank-level database that identifies inter- increasingly come from local customer depos- national and domestic banks by developing its, which the global financial crisis proved to indices of the internationalization of bank lia- be a more stable source of funding, enabling bilities, and it investigates the performance of these banks to better smooth their lending international banks vis-à-vis domestic banks throughout the crisis (figure O.10). in the 112 countries where they are headquar- Nevertheless, South–South banks may tered (Bertay, Demirgüç-Kunt, and Huizinga also bring increased risks, which stem from 2017). more lax regulation in their home countries. The results suggest that international- Indeed, Claessens and van Horen (2016) and ization smooths banks’ credit supply over Mehigan (2016) find that foreign banks based the business cycle, particularly for develop- in countries with relatively laxer regulatory ing country international banks. Figure O.9 requirements could amplify credit booms in shows the change in bank lending associated host countries. The extent to which foreign with a 1 percent increase in real GDP per banks based in the South will be committed capita growth, for domestic and international to the host countries and therefore limit shock banks headquartered in high-income or de- transmission versus the extent to which their veloping countries. In general, bank lending is potentially weaker regulatory and supervisory procyclical, increasing during booms and fall- frameworks will become a source of instabil- ing during downturns. Yet, particularly in de- ity is not clear a priori, and thus needs future veloping countries, the lending pattern of do- research. Also, because regionalization by mestic banks is significantly more procyclical definition means less risk sharing, questions in response to local business cycles compared remain whether there is an optimal mix of with their international counterparts. foreign bank entries from global as well as re- Furthermore, these data show that the gional banks, so as to maximize the potential funding of South–South subsidiaries has benefits. 16 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FIGURE O.10 Contribution of Local Deposits to Banks’ Total Funding at least partially for the decline in bank fund- ing. Demirgüç-Kunt, Martínez Pería, and 70 Tressel (2017) analyze the capital structures of firms during the crisis by investigating a 65 large panel of listed and nonlisted firms over 60 the 2004–11 period, with good coverage of SMEs. They show that firms listed on a stock % of total funding 55 market have, on average, experienced a much 50 more moderate decline in leverage and in the use of long-term debt (figure O.12). These 45 findings are consistent with the view that 40 capital markets may have played the role of a 35 spare tire for publicly listed firms, by provid- ing an alternative source of external finance 30 and better information when the functioning 2000 2002 2004 2006 2008 2010 2012 2014 of the banking system was impaired during NN NS SN SS ND SD the crisis (Levine, Lin, and Xie 2016). These patterns highlight not only the ben- Source: Calculations based on Bertay, Demirgüç-Kunt, and Huizinga 2017. Notes: NN corresponds to bank subsidiaries from developed countries operating in developed efits of having alternative sources of finance countries. NS corresponds to bank subsidiaries from developed countries operating in developing but also the need to broaden the policy dis- countries. SN corresponds to bank subsidiaries from developing countries operating in developed countries. SS corresponds to subsidiaries from developing countries operating in developing cussion to consider the financial system as a countries. ND corresponds to domestic banks in developed countries. SD corresponds to domestic whole. When firms obtain financing from dif- banks in developing countries. ferent sources, it is important to jointly ana- lyze the different types of financing. Having access to different markets might allow firms FOCUS AREA 2: THE SHIFT to compensate for fluctuations in particular TOWARD ALTERNATIVE markets by raising funds elsewhere. As such, SOURCES OF FUNDING countries might reduce contagion risks by di- When the global financial crisis suddenly hit versifying the sources of finance and, to the the banking sectors of major high-income extent possible, having more complete mar- countries, firms around the world compen- kets, including equity markets. Policy initia- sated for this contraction by substituting tives, such as the Capital Markets Union in across funding sources. Cortina, Didier, and Europe, aimed to increase the substitutability Schmukler (2016) use issuance data for large between bank loans and other sources of ex- corporates in domestic and international ternal finance (European Commission 2015), bond markets and syndicated loan markets as well as those that aimed to develop innova- to show that in high-income and developing tive instruments, such as minibonds, and secu- countries, firms with access to capital markets ritization may be important (Borensztein and moved to bond markets (figure O.11). In de- others 2008; Giovannini and others 2015). veloping countries, these firms also switched However, these shifts do not alleviate the to domestic banks and away from interna- funding constraints of smaller firms with- tional banks. Due to these switches, global out access to markets. Cortina, Didier, and financial activity during the crisis declined less Schmukler (2016) discuss the importance of than the collapse in cross-border loans. These considering the compositional change in the changes in debt composition continued dur- types of issuers that are tapping each mar- ing the postcrisis period. ket over time. For instance, during domestic The importance of well-functioning do- crises, only the relatively larger firms have mestic capital markets as a “spare tire” was access to alternative markets such as bonds confirmed during the global financial crisis and international loans. The work of these period in many countries, as they substituted researchers shows that during foreign shocks, GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 17 FIGURE O.11 Volume of Debt Issuance over Time for Real Purposes a. High-income countries b. Developing countries 3,000 700 2,500 600 2011 U.S. dollars (billions) 2011 U.S. dollars (billions) 500 2,000 400 1,500 300 1,000 200 500 100 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Corporate bonds Syndicated loans Total debt Source: Thomson Reuters SDC Platinum (database). Note: This figure displays the aggregate amount raised per year for real purposes in corporate bond and syndicated loan markets by high-income (panel a) and developing countries (panel b). Real purposes refer to the exclusion of bonds and loans used for acquisition financing and leveraged buyout operations, refinancing, and capital structure management, as well as other issuances whose purposes cannot be categorized as real investments (such as those with unspecified purposes or with missing information). FIGURE O.12 Average Change in Long-Term Debt Tressel (2017) as well, the decline in leverage Financing, by Ownership Type and in long-term debt financing after the crisis was particularly pronounced among all non- 0.5 listed firms, a large proportion of which are 0 0.04 SMEs (figure O.12). Hence, for smaller firms Average change in long-term debt to with limited or no access to capital markets, –0.5 total asset (percentage point) the important role of banks remains. –1.0 –1.13 –1.5 –1.40 FOCUS AREA 3: THE RISE OF –2.0 –1.71 FINTECH—OPPORTUNITIES AND –2.13 –2.5 CHALLENGES –3.0 Technology is also changing the banking sec- –3.5 –3.74 tor and could have major implications for ac- –4.0 cess, efficiency, and financial sector stability. All firms Listed firms Nonlisted firms Fintech—technology-driven new companies High-income countries Developing countries providing financial services outside the tra- ditional financial sector—can reshape com- Sources: Demirgüç-Kunt, Martínez Pería, and Tressel 2017; Bureau van Dijk ORBIS (database); and staff calculations. petition among financial providers and thus Note: The data set covers 277,000 firms across 79 countries over the improve the delivery of financial services and period 2004–11 and is composed mostly of SMEs; 98.7 percent of firms are not listed on a stock exchange. increase access. Global investment in fintech companies has expanded very rapidly world- wide. Although data on fintech are as yet very large international firms switching to domes- scant, there were at least 4,000 active fintech tic markets can potentially crowd out smaller firms in 2015; and more than a dozen of them domestic issuers from the market. In the were valued at over $1 billion (The Econo- work of Demirgüç-Kunt, Martínez Pería, and mist 2015). 18 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Large foreign banks that can devote more sell any products—including illegal ones, such resources to research and development are as drugs and guns—by using Tor, an anony- likely to play an important role in this process. mous browser, and bitcoin, an anonymous Although, at first, fintech helped financial in- form of payment. stitutions speed up transactions at a lower Because certain aspects of fintech’s devel- cost, the most recent technologies encompass opment remain lightly regulated, how this a variety of services, such as data security, risk new area of finance should be regulated and management, mobile banking and alternative supervised is generating an active debate. The currencies. For example, Blockchain, which is new lending practices used by the online plat- an immutable shared electronic record, makes forms seem to be one of the main hot spots lightning-fast transactions possible compared for regulators to date. For instance, lending with traditional bank transfers or settlements discrimination against consumers, disclosure of securities trades. In principle, digital finan- requirements for SMEs, and the sharing of cial services, and in particular those provided consumer data are some of the most relevant via mobile telephony, hold the promise of areas of concern currently being dealt with by deepening financial inclusion to market seg- regulators in the United States (Politico 2016). ments that have been underserved (Ahmed Moreover, because fintech companies usually and others 2015). Hence, fintech is likely to have a base of more vulnerable customers— facilitate the provision of financial services they are bringing some customers into the fi- and affect how banks compete with each nancial system for the first time—consumer other (and with other, nonbank providers of education and protection measures are much financial services) for all market segments and needed. Another source of concern is that fi- across geographical boundaries, which could nancial regulation remains region-specific and have broader implications for access, effi- fragmented, but many fintech firms work glob- ciency, and financial sector stability. ally or offer digital products that are difficult Despite its potential, fintech can also pose to contain within the borders of a particular new challenges for both the financial system economy. Thus, it is not clear which econo- and policy makers. The main vulnerabilities my’s laws would be applied to a company. that the new digital financial practices are Some regulators seem to understand that ex- bringing to the financial sector include the cessive regulation might be deadly for the fin- lack of safety nets in their business models, the tech start-ups and are developing regulatory misuse of personal data, difficulties in identi- sandboxes to manage the transition to a new fying customers, and electronic fraud. Most landscape. This approach allows for the live peer-to-peer lending platforms act as brokers testing of fintech services with a low level of between borrowers and investors, and thus regulation for a defined period, helping to un- they do not bear the risk of those loans on derstand the risks that the new products might their balance sheets. Because they rely on entail in a controlled environment. This way, new transactions to make profits, their main the sandbox enables regulators to work with source of funding might evaporate during a fintech companies to ensure that appropri- downturn. Moreover, the algorithms used to ate consumer protection safeguards are built evaluate credit profiles might involve discrim- into their new products and services before inatory systems—by, for example, discrimi- these reach a mass market (Financial Conduct nating against borrowers in poorer areas and Authority 2015). The United Kingdom has other vulnerable segments (U.S. Department launched its sandbox, and other jurisdictions of the Treasury 2016). With respect to pay- are following similar initiatives—such as Aus- ments, the anonymity, speed, and global reach tralia, Singapore, and, more recently, Hong of the cryptocurrency payment system makes Kong SAR, China (Financial Times 2016a). illicit transfers easier. An example of this Regulators in the United States are also con- was “Silkroad,” an anonymous e-commerce templating a sandbox approach (Wall Street platform that allowed customers to buy and Journal 2016). New, digitally enabled methods GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 OVERVIEW 19 can also potentially be used to address compli- the advantage of scale and incumbency in a ance requirements and the monitoring of digi- heavily regulated industry. This fosters coop- tal financial services, such as “regtech” (Arner, eration between banks and fintech compa- Barberis, and Buckley 2016; Financial Times nies. Fintechs gain access to banks’ scale and 2016b). customers, and banks can exploit fintechs’ ex- Regulating and monitoring the develop- pertise in programming and in analyzing large ment of an industry that is rapidly growing databases. Nevertheless, the impact of fintech will remain a key challenge in the future. On and newly developed digital technologies on one hand, redundant and inefficient regula- the global financial sector is expected to keep tions may hinder fintech’s potential for pro- rising in the years to come. moting overall financial development. On the other hand, policy makers need to constantly NOTE monitor and adapt proper regulatory frame- works that keep pace with the speed at which 1. Cross-border bank lending activity is com- parable to bond issuances and equity market financial innovations occur. Although the activity. The annual total value of foreign new players are increasing competition and syndicated loans issued globally, which repre- pushing digital transformation in the global sents only a subset of new foreign bank lend- financial sector, to date the level of disruption ing, was $2.5 trillion in 2006 and $3.0 trillion seems low and their services appear highly in 2015. For comparison, the total value of complementary to the ones provided by the global cross-border bond issuances was $3.2 more established banking sector. Banks enjoy trillion in 2006 and $3.8 trillion in 2015. CHAPTER 1: KEY MESSAGES • International banks operate in foreign countries through local affiliates and cross-border lending. They offer opportunities to promote economic development because they bring with them capital, liquidity, expertise, and new technologies, which can lead to more investment, greater competition, and better resource allocation. International banks also play a risk- sharing role—that is, they can help host countries stabilize their credit supply during a local downturn, and they can shift resources back to the home country when conditions at home worsen. However, there are also reasons for caution. Borrowing from abroad involves risks such as foreign exchange exposures and other mismatches. Risk sharing can also expose host countries to systemic risks from time to time. And because global finance tends to be more procyclical than domestic finance, this factor could more easily lead to boom-bust cycles in poor institutional environments. • The presence of international banks, as measured by their foreign claims, quadrupled in the decade leading up to the global financial crisis in 2007–09, but it has since dropped and stag- nated. In fact, although the number of foreign banks exiting markets remained more or less the same, there was much less entry after the crisis, and net entry became negative for the first time since 1995. Despite this decline, lending by international banks remains an important source of finance for private and public sectors across the world. Notably, the volume of for- eign bank claims • Financial via local systems lending now exceeds are multidimensional. Fourthat of cross-border characteristics are lending because of particular lending interest brick-and-mortar by for benchmarkingbanks has systems: financial proven tofibe more depth, nancial resilient in response access, to financial efficiency, distress. and stability. These characteristics need to be measured for financial institutions and markets. • Indeed, the participation of foreign banks through branches and subsidiaries was rising in all regions until systems • Financial recent years comewhen the in all major shapes global and banks sizes, began widely and differ to retrench theirof international in terms the four operations. Although banks from high-income countries drove exits, developing characteristics. As economies develop, services provided by financial markets tend countries to continued their foreign bank expansion, accounting become more important than those provided by banks. for close to 60 percent of new entries. Thus, two important trends have emerged: South–South banking and regionalization. By • The global financial crisis was not only about financial instability. In some economies, 2013, banks from high-income countries still represented 89 percent of foreign bank assets the crisis was associated with important changes in financial depth and access. globally, but this share was 6 percentage points lower than before the crisis, representing a greater diversity of foreign bank ownership. Foreign bank presence also became more re- gionally concentrated, with the average intraregional share increasing by 4 percentage points, largely reflecting developing country banks expanding into space opened up by the retrench- ment of global banks. • Another trend in bank internationalization is the dramatic increase in bank size, with the assets of the largest banks worldwide increasing by more than 40 percent from 2005 to 2014. Despite regulatory efforts after the global financial crisis to address too-big-to-fail issues, bank size has not shrunk in either absolute terms or relative to gross domestic product (GDP). The largest banks are also the ones that are active at the international level. • Since 2007, with the backlash against globalization, many countries, including many develop- ing ones, have been adopting increasingly restrictive policies that directly and indirectly affect the presence of foreign banks. All in all, restrictions on international banking activities increased after the global financial crisis. • Overall, international banking can have important benefits for development by improving efficiency and risk sharing, but benefits do not accrue unless the institutional environment is developed and the right policies are adopted. Thus, the challenge for policy makers is to provide an environment that will maximize the benefits from internationalization while mini- mizing the costs. The key to addressing this challenge is to devise policies acknowledging that benefits and costs vary, depending on bank characteristics and home and host country conditions. The rise of South–South banking ties as well as the emergence of new financial technologies will also present new challenges for policy makers. CONCEPTUAL FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY 1 Conceptual Framework, Stylized Facts, and the Role of Policy INTRODUCTION best uses, enabling diversification of risk, mo- bilizing and pooling savings (thereby enabling nternational banks can play an important I role in shaping financial and economic de- velopment. They may bring much-needed capital, liquidity, and technological expertise large, indivisible, and long-term investments through maturity transformation), facilitating the exchange of goods and services (such as via payment services), and monitoring firms to host countries. In return, however, they and managers (Levine 1997). The ability of will expect high returns, diversification bene- a bank to perform these functions changes fits, and growth opportunities. In fact, histori- when it operates in an international setting as cally such international activities have been opposed to autarky, and this change has im- essential to banking (see box 1.1). plications for the owners of the bank and its This chapter provides a conceptual frame- home country (the country in which the bank work for understanding the dynamics of in- is headquartered) and for the clients of the ternational banking, its effects on economic bank in both home countries and host coun- development, and the scope for public policy. tries (the foreign countries in which banks op- The chapter then introduces relevant defini- erate). Box 1.2 provides the definitions needed tions and stylized facts that shed light on re- to understand international banking and illus- cent trends and pave the way for the analyses trates how stakeholders in different countries in the rest of the report. The chapter con- interact through international banks. cludes with a discussion of the policy implica- Banks expand their activities to other tions and the prospective role of government countries to further diversify risk, to realize in international banking. higher profits, and to achieve economies of scale. Banks also have a long tradition of fi- A CONCEPTUAL FRAMEWORK nancing trade across borders—and sometimes FOR UNDERSTANDING even following their client firms involved in INTERNATIONAL BANKING international trade (Cull and Martínez Pería Banks provide many important functions that 2010). Risk diversification is particularly suc- facilitate economic activity. These functions cessful if the home country faces shocks that include allocating scarce resources to their are not highly correlated with shocks in the GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 21 22 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 1.1 A Brief Historical Perspective on International Banking The internationalization of money and fi nance can Dutch banks and syndications. In addition to financ- be traced back to the fourth century A.D., when the ing trade, Dutch banks funded foreign governments bezant was introduced by Emperor Constantine of throughout the 17th and 18th centuries. In the lat- Byzantium and effectively used as an international ter period, they began to share the financing of these currency in the Mediterranean region (Lothian loans with other merchants and wealthy individuals 2002). Although not on a scale comparable with and to sell these bonds to the rest of Europe through globalization in modern times, banks were involved the Amsterdam stock exchange—early examples of in cross-jurisdictional activities for centuries. What syndicated loans and securities underwriting. follows, based largely on Roussakis (1997), is an account of the historical international banking Industrialization and the rise of modern global strongholds that dominated global fi nance. banks. At the dawn of 19th century, the long-term financing needs for industrial investments were Early banks from 15th-century Italy. Even in the met through bond and equity issuance, largely in Middle Ages, banks that were succeeding in local London. Merchant banks such as Baring Brothersa city-states sought to increase the geographical reach were among the most important players, channel- and scope of their operations. Their efforts contrib- ing capital across the Atlantic. It was also common uted to international trade and sovereign debt fund- practice for foreign governments to raise funds in ing. For example, in the mid-15th century Medici London (see, for example, Reinhart and Rogoff Bank in Florence had branches in Rome, Venice, 2008) and for foreign banks to be established with Avignon, London, Bruges, and Geneva; it distributed foreign capital.b Indeed, it has been widely acknowl- liquidity from the papal deposits through its branch edged that the second half of the 19th century saw network (Roussakis 1997). Eventually, the bank- the first wave of globalization, in which multina- ruptcy of the bank resulted at least in part from the tional banking activity increased dramatically. For losses in its “foreign” branches stemming from sover- example, Battilossi (2006) reveals that the number eign delinquencies (De Roover 1963). of foreign branches of British, French, and Ger- man banks increased from 525 in 1880 to 1,610 in Emergence of German merchant banks. In the 16th 1913. Accompanied by the gold standard in many century, German banks emerged, sometimes replac- countries, which provided monetary stability and ing the services provided by Italian banks. They reduced exchange rate risk, capital moved almost became widely involved in fi nancing trade, providing freely around the world, mostly from Europe to credit to industry, and fi nancing sovereigns such as North America and Latin America. Finally, the 20th the Tudors of England and the Hapsburgs of Europe. century saw U.S. and Japanese banks emerging as The German banks, notably the Fugger, financed global banks, which led to the globalization trend assets in part through the money markets in Antwerp in recent decades, strengthened by technological (Roussakis 1997). advances and fi nancial deregulation. a. In 1890 Baring Brothers suffered a liquidity crisis because of its deteriorating loan portfolio concentrated in Latin America. Eventually, leading fi nancial institutions in London had to guarantee Baring’s liabilities in an effort orchestrated by the Bank of England—an early example of a bank bailout/rescue (Baker and Collins 1999; Cassis 2013). b. For example, the Ottoman Bank, established in the mid-19th century in Istanbul, was founded mostly by British and French capital. See http://www.obarsiv.com/english/history.html. host country (García-Herrero and Vázquez other types of flows—such as when foreign 2013). This situation often arises when the banks help deepen local capital markets in host country is in a different geographic re- host countries or increase the flows of foreign gion. More broadly, banking activity is one direct investment (FDI) to nonfinancial sec- way in which capital flows from low- to tors (Ongena, Qi, and Qin 2014; Poelhekke high-return countries, and in many cases in- 2015). From the perspective of borrowers in ternational banking activities interact with host countries, the diversity of funding sources GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FRAMEWORK, FACTS, AND THE ROLE OF POLICY 23 BOX 1.2 Useful Definitions for Understanding International Banking in the Financial System After decades of internationalization, international tional banks that own foreign bank subsidiaries in banks remain quite heterogeneous, and further cat- host countries. c Domestic banks, by contrast, are egorization is helpful in distinguishing their differ- banks that do not own foreign bank subsidiaries; ences from each other and from other banks in their nor are they owned by foreign (banking) entities. In home countries. In this report, an international short, foreign banks are defi ned by the nationality bank is defined as one with cross-border lending of their ownership, whereas international banks are facilities or foreign bank subsidiaries or both. Some defi ned by the geographical scope of their business international banks have emerged as global giants in and operations. both size and international reach. A standard defi ni- As shown in figure B1.2.1, all agents in both tion of a global bank does not exist. a Thus here a countries may directly interact with the financial global bank is defi ned as a large international bank markets through different operations. Bidirectional with activities in multiple regions. The banking flows, including round-tripping transactions, are also landscape is also populated with regional banks — identified in the figure. In addition to the net flows, those that focus on a specific region (or set of coun- these interactions are crucial, as noted by Avdjiev, tries)b —and domestic banks —those that have only McCauley, and Shin (2015)—that is, gross flows home country operations. Global and regional matter in assessing the amount of the risk in the banks —located in home countries —are interna- banking system.d FIGURE B1.2.1 How the International Banking System Works Foreign claims Domestic banks International Syndicated loans, equity investment banks capital injection, intragroup loans Foreign (i.e., global and Dividend payments, profit transfers, banks regional banks) intragroup loans Direct loans, syndicated loans Borrowers Savers Financial markets Shadow banking system, capital markets, bond and equity issuance,special-purpose vehicles, wholesale funding, money market funds a. The most relevant official defi nition is that used for a global systemically important bank (G-SIB) by the Bank for International Settlements (BIS) in which factors such as bank size and cross-jurisdictional activities, among others, are considered (details are discussed in box 1.4). b. For example, the Austrian Erste Group, which has assets totaling some € 200 billion, is active in seven countries in the Europe and Central Asia (ECA) region. By contrast, as of the end of 2014, State Street Bank, a U.S. bank of similar size, was active in 29 jurisdictions—Canada, Germany, India, Ireland, Italy, and the United Kingdom, among others. The Austrian Erste Group is not in the global bank sample of BIS, whereas State Street Bank is a G-SIB. c. International banks may also own foreign branches in host countries. The main difference between a foreign branch and a foreign bank subsidiary is that the branch is regulated by the home country and the subsidiary is regulated by the host country. Moreover, unlike foreign branches, foreign bank subsidiaries are locally chartered, self-standing banks with their own capital—see Cerutti, Dell’Ariccia, and Martínez Pería (2007) for details. d. The aspect of currency denominations described by Avdjiev, McCauley, and Shin (2015) is not included in this framework. According to these authors, international currencies serve as “funding currency.” For example, the U.S. dollar plays the preeminent role in international banking because non-U.S. banks also use the dollar in their transactions. In line with this, the currency mismatch in the real sector debt creates a “risk-taking channel,” as noted by Bruno and Shin (2015b), and yields the relationship between the exchange rate and fi nancial stability. 24 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 from foreign as well as domestic banks low- pressures, but they apply mostly to large firms ers the risk of losing credit during crises or and not small and medium-sized enterprises domestic downturns (Goldberg, Dages, and (SMEs) and households because of fixed costs Kinney 2000). and information problems.1 Those problems International bank flows are characterized are directly addressed by bank business mod- by important differences when compared with els through economies of scale and monitoring other types of capital flows, such as debt and and screening activities (such as collecting equity investments. These differences can be valuable information from deposit services). traced back to the uniqueness of the bank Benefits for the underserved segments unable business model. First, banks have the ability to tap into capital markets for funding could to reduce information asymmetries between occur in two ways: (1) foreign banks could savers and users of funds through screening directly penetrate those segments through and monitoring (Diamond 1984; Fama 1985). transactional lending approaches (Beck, Ioan- Second, banks are vulnerable to bank runs be- nidou, and Schäfer 2012) or relationship cause of their obligation to provide immediate banking (Beck, Degryse, and others 2014); or access to depositors’ funds on demand (Dia- (2) foreign banks could force domestic banks, mond and Dybvig 1983; Diamond and Rajan in search of profit margins dimmed by foreign 2001). Third, because of this vulnerability, competition, to serve those previously ne- banks tend to be supported by a financial glected segments. In fact, foreign banks do not safety net (such as deposit insurance or bank need to enter a contestable banking industry access to the short-term discount windows to create competitive pressures—the sheer provided by central banks), possibly inducing threat of entry by foreign banks may lead to moral hazard and greater risk-taking incen- more efficient financial intermediation (Claes- tives (Demirgüç-Kunt and Detragiache 2002). sens, Demirgüç-Kunt, and Huizinga 2001; Finally, because of this tendency to take ex- Claessens and Laeven 2004). And yet, the con- cessive risks, banks often face tight regulatory tribution of international banking to financial measures—mostly on a national level with development depends on the characteristics of limited cross-border coordination. These dif- parent banks (such as the health of their bal- ferences are conceptually important because ance sheets) and foreign subsidiaries (such as they can determine the international banking the use of relationship banking techniques), as landscape and the economic outcomes of in- well as the market conditions in the host coun- ternational banking activities in both home try (such as the existence of credit information and host countries. Depending on the institu- and contract enforcement). tional environment, quality of regulation and By contrast, in weak institutional environ- supervision, macroeconomic stability in home ments with poor information and contract and host countries, and the different charac- enforcement, international banks may focus teristics of international banks, cross-border only on large corporations or governments banking activities that bring benefits may also (so-called cherry picking or cream skimming). lead to certain costs for stakeholders, suggest- Such a focus on large borrowers may result ing an important role for government. in the exclusion of poor households or SMEs from the financial system, thereby reducing access to finance (Detragiache, Tressel, and INTERNATIONAL BANKING AND Gupta 2008).2 Furthermore, intensified com- ECONOMIC DEVELOPMENT petition and reduced profitability may lead to Foreign banks can increase competition in the higher risk taking by domestic banks (particu- banking industry, leading to more efficient larly in the presence of financial safety nets), resource mobilization and allocation and which can lead to moral hazard.3 For example, greater access to finance for both firms and a domestic bank in a developing country may households. International debt and equity in- extend foreign currency–denominated credit vestments should also create such competitive to households that do not have any capacity GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FRAMEWORK, FACTS, AND THE ROLE OF POLICY 25 to hedge, implying high credit risk and vul- And yet in another study, for a large panel of nerability to exchange rate fluctuations. High countries a foreign bank presence is also posi- risk taking may also be associated with for- tively related to inequality (Delis, Hasan, and eign banks if their parent banks try to use Mylonidis 2016). This relationship, however, them to avoid relatively more stringent regu- tends to turn negative when institutional and lation and supervision in their home coun- regulatory differences between home and host tries—that is, engage in regulatory arbitrage countries are sufficiently large or when foreign (Ongena, Popov, and Udell 2013). Indeed, banks maintain a large presence in host coun- international banks, and especially global sys- tries for extended periods of time, suggesting temically important banks (G-SIBs), are very gradual improvement. All in all, even though complicated to supervise and to unwind, and international banks can potentially increase thus they pose serious challenges in cross- efficiency and access, the informational, insti- border bank regulation, supervision, and res- tutional, and regulatory environments in both olution in both home and host countries and home and host countries play a crucial role in require cross-border cooperation. determining the effect of international bank- Another channel through which interna- ing on economic development. tional banking can promote financial and economic development in host countries is INTERNATIONAL BANKING AND by providing additional human capital and FINANCIAL STABILITY knowledge. Foreign bank entry can lead to improvements in the technology of the host The presence of international banks is likely country’s financial systems and business mod- to be accompanied by greater financial in- els of domestic banks, allowing firms and flows and outflows for host markets as part households to access more sophisticated fi- of risk sharing, which could be stabilizing for nancial services (de la Torre, Martínez Pería, the local credit supply overall. For example, and Schmukler 2010). Foreign banks could international banks are more likely than do- also impose discipline on policy makers and mestic banks to maintain their lending in host regulators by breaking the political entrench- countries during local economic downturns, ment of certain connected firms in the finan- thanks to their deep pockets and possibly cial system that often leads to highly ineffi- long-term investment horizons (De Haas and cient resource allocation and bad development van Lelyveld 2010). On the other hand, in- outcomes.4 ternational banks appear to curtail credit in Empirical evidence suggests that a foreign host countries more aggressively than domes- bank presence fosters a country’s economic tic banks when a crisis hits the international growth and entrepreneurship and, under banks’ home country. This then allows these some conditions, reduces inequality. For ex- international banks to perform better in their ample, Bruno and Hauswald (2013) analyze home country when compared with domes- data for 36 manufacturing industries across tic competitors without foreign subsidiaries 81 countries and find that a foreign bank (De Haas and van Lelyveld 2014; Peek and presence displays a strong positive correla- Rosengren 1997, 2000). International banks tion with economic growth in industries with thus share risk between host and home coun- greater dependence on external finance. This tries, transferring funds from home to host finding is particularly strong for developing countries when a host country crisis hits, economies, where informational and legal and transferring funds from host to home frictions often hinder access to credit. Simi- countries when a home country crisis hits. larly, according to Alfaro, Beck, and Calo- Although this risk-sharing arrangement im- miris (2015), in developing countries a greater plies greater financial flows, it allows both foreign bank presence is associated with a host and home countries to buffer the greatest higher share of business formation in indus- shocks to their credit supply, thereby stabiliz- tries with a greater need for external finance. ing credit overall. 26 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Nevertheless, international banks may also banking industries, the existing financial and fuel credit booms in host countries that end up information infrastructure, the mode of entry in busts if domestic financial systems are not of the international banks (cross-border lend- capable of handling such flows.5 Credit booms ing versus brick-and-mortar operations via may occur, for example, if international banks subsidiaries or branches, or greenfield versus lower lending standards (Dell’Ariccia and mergers and acquisitions), and the financial Marquez 2006a). These booms may end up characteristics (such as funding structure) of in busts that are exacerbated if international the parent bank or foreign affiliate (Bertay banks choose to exit. Such behavior—ampli- 2014; De Haas and van Horen 2013; Schnabl fied by global risk and liquidity conditions— 2012). Policy making that affects or stipulates could be harmful to the financial stability of these characteristics may thus have an impor- the home or host countries, ending in costly tant influence on host country experiences boom and bust cycles and cross-border con- with international banks, which is discussed tagion risks (Forbes and Warnock 2012).6 in the coming chapters. Moreover, developing countries or small International bank lending is an impor- economies could also be negatively affected tant source of funds for developing coun- because their monetary policy cannot influ- tries compared with international financial ence the decisions of large international banks, market activity and FDI. International banks making monetary policy less effective.7 are involved in two main types of interna- The global financial crisis revealed that tional activities: (1) cross-border lending and the extent to which international banks shift (2) foreign participation in domestic banking funds from host to home countries during a systems through brick-and-mortar opera- home country crisis is related to a number of tions—that is, where the bank is physically country and bank characteristics. These char- present in a country through an office, which acteristics include the cultural and institutional can be a branch or part of a foreign bank sub- distance between the home and host coun- sidiary owned by the bank. These two activi- tries and their relative legal and regulatory ties are the main focus of this Global Finan- frameworks, the structure of their respective cial Development Report 2017/2018 (GFDR), and they are discussed in the next two chap- ters.8 Figure 1.1 illustrates the importance of FIGURE 1.1 Foreign Financial Inflows to Developing Countries: international banking activity in developing Syndicated Loans, Bonds, and Foreign Direct Investment, 2000–15 countries compared with foreign bond issu- ances and FDI. These comparisons are not 800 straightforward because data on international bank activities include bond issuances and eq- 700 uity holdings (see box 1.4 later in this chap- 600 ter), data on bond issuances include bonds held by banks, and FDI includes equity invest- Flows (US$, billions) 500 ments by banks. For a cleaner comparison, 400 figure 1.1 focuses on issuances of syndicated 300 loans led by foreign banking entities, which is only a fraction of all cross-border bank loans, 200 but has the advantage of excluding bond and 100 equity activity. These numbers thus provide a lower bound on the value of international 0 bank lending. Despite being a lower bound, 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 foreign syndicated loan issuances were much 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Syndicated loans Bonds FDI net inflow larger than foreign bond issuances before the global financial crisis (in 2006, $239 billion Source: World Bank, World Development Indicators (database) and FinDebt (database). for syndicated loans versus $117 billion for GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FRAMEWORK, FACTS, AND THE ROLE OF POLICY 27 bonds). In the years following the global fi- FIGURE 1.2 Foreign Claims Reported to BIS by Counterparty Income nancial crisis, cross-border bond issuances Level, 2000–15 overtook the foreign syndicated loans, but their sizes were still comparable (in 2015, 35 $233 billion for syndicated loans versus $292 30 billion for bonds).9 The issuance of syndicated loans led by foreign banks represented about 25 Claims (US$, trillions) one-third of the volume of FDI net inflows in the postcrisis years. 20 International banking activity increased 15 dramatically from 2001 until the global finan- cial crisis in 2007–09, but it did not recover 10 from the retrenchment in high-income coun- 5 tries during the crisis. Figure 1.2 reveals that all foreign exposures of international banks 0 from Bank for International Settlements (BIS) 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 reporting countries increased from $8.6 tril- Claims on developing countries Claims on high-income countries lion in 2000 to $31 trillion in 2008. After the crisis, the international banks reduced their Source: Consolidated Banking Statistics (Immediate Risk Basis), Bank for International Settlements. exposures, leading to a significant retrench- ment (by the end of 2015 total foreign claims were $24 trillion, or 22.5 percent lower than in 2008). This retrenchment came from a the Sub-Saharan Africa (SSA) regions wit- reduction of foreign claims in high-income nessed the greatest declines in foreign lending; countries rather than developing countries, in both regions, foreign claims on the non- where foreign exposures remain resilient in bank private sector, with respect to domestic absolute terms. Another recent development credit to the private sector by banks, were in the global financial arena is the rise of half of their respective peak values in 2005 international microfinance institutions (MFI) (SSA) and 2008 (MENA). (see box 1.3). Foreign claims mostly fund the nonbank Despite the significant decline after the private sector, particularly in developing global financial crisis, lending by interna- countries. At their highest level (in 2008), tional banks continues to represent an impor- foreign claims going to the nonbank private tant share of total bank credit in many coun- sector reached almost 43 percent of gross do- tries. Data on lending by international banks mestic product (GDP) in high-income coun- are provided primarily by BIS. BIS data on tries and 32 percent of GDP in developing foreign claims cover both cross-border lend- countries. By contrast, foreign claims going to ing and loans made by foreign-owned banks the official sector have typically remained be- within a country (see box 1.4 for a more de- low 10 percent of GDP in high-income coun- tailed description of foreign claims and box tries and below 4 percent of GDP in devel- 1.5 for alternative sources of data).10 De- oping countries. Panel b in figure 1.3 shows spite the postcrisis decline, lending by foreign large reductions in foreign lending to banks banks accounted for 27.6 percent of credit and the nonbank private sector, as a percent- to the private sector in developing countries age of GDP, after 2008 in both high-income in 2014 (in high-income countries, 40.6 per- and developing countries, whereas lending cent). As panel a of figure 1.3 shows, both to governments by international banks in- the extent of the foreign bank presence and creased. Given the relative resilience of total the impact of the crisis varied by region from foreign claims in developing countries (see 2005 to 2014. After the 2007–09 crisis, the figure 1.2), these reductions in relative values Middle East and North Africa (MENA) and to GDP indicate that international banking 28 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 1.3 The Rise of International Microfinance Institutions Over the last two decades, international microfi- investors in these MFIs are primarily development nance institutions (MFIs)—institutions affiliated finance institutions, including the African Devel- with a common owner that have operations in dif- opment Bank (AfDB), European Investment Bank ferent countries—have emerged and have focused (EIB), International Finance Corporation (IFC), on expanding access to fi nancial services around the and KfW Development Bank. The holding company world. Many of these institutions follow the green- model has provided depository fi nancial institutions field business model, which has two main elements: with a single vehicle for making larger investments in (1) creation of a group of “greenfield MFIs,” defi ned microfi nance and leveraging their participation with as institutions that are newly created without preex- other investors (Earne and others 2014). isting infrastructure, staff, clients, or portfolios; and Cull and others (2015) have studied the role of (2) use of central organizing bodies—often holding greenfield MFIs in promoting the quality, breadth, companies—that create these MFIs through com- and depth of usage of financial services in Sub- mon ownership and management. The holding com- Saharan Africa (SSA). According to their analysis, pany usually also plays a large role in backstopping relative to other African microfinance providers, operations, formulating standard policies and proce- greenfield MFIs grew faster, improved profitability dures, providing staff development and training, and to levels comparable to those of the top MFIs, and cobranding the subsidiaries in the network (Earne substantially increased their lending to women. Table and others 2014). Examples of these greenfield MFIs B1.3.1 illustrates some of these fi ndings. Greenfield are Access, Advans, BRAC, FINCA, and ProCredit. MFIs in Africa started out with a smaller number of Some holding companies such as Access, Advans, loans and deposits than other MFIs and with a worse and ProCredit were founded by specialized microfi- fi nancial performance, but they saw a rapid increase nance consulting fi rms with the purpose of invest- in both loans and deposits during their fi rst few years ing in and building a global network of subsidiaries. of operation. The numbers also show that, after five Others, such as BRAC and FINCA, were established years in operation, greenfi eld MFIs had a positive to consolidate the affiliates of existing microfi- net income, whereas other MFIs had a negative net nance networks and expand them by creating new income. Overall, Cull and others (2015) conclude greenfields. that, although the loan sizes of greenfield MFIs are Greenfield MFIs are typically driven by a mission larger than those of most African MFIs, indicating to expand access to financial services and to pro- less outreach to the poorest market segments, green- mote economic development while offering commer- field MFIs have achieved rapid gains in financial cial success for their shareholders. Shareholders and inclusion for somewhat more affluent clients. TABLE B1.3.1 Evolution of Greenfield MFIs in Sub-Saharan Africa during Initial Years of Operation Greenfields Measure Month 12 Month 36 Month 60 MIX young Africa No. of staff 131 318 524 69 No. of branches 9 22 31 10 No. of loans outstanding 9,495 25,009 36,714 11,255 Gross portfolio (US$, millions) $2.3 $9.2 $20.0 $2.7 No. of deposit accounts 7,123 37,460 81,682 18,127 Deposits (US$, millions) $0.8 $8.7 $23.1 $2.0 Share of portfolios at risk >30 days 3.9% 4.0% 3.4% 9.5% Operating expenses/portfolio 200% 53% 36% 113% Equity (US$, millions) $3.6 $4.3 $6.6 $1.2 Net income/assets −12.4% −0.1% 3.1% −2.4% Net income/equity −44.6% −0.3% 18.9% −3.4% Source: Cull and others 2015. Note: MIX young Africa refers to MFIs four to seven years old that report to the Microfi nance Information eXchange (MIX). The original underlying data were provided by MIX and the International Finance Corporation. BRAC = Building Resources Across Communities; FINCA = Foundation for International Community Assistance; and MFI = microfi nance institution. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FRAMEWORK, FACTS, AND THE ROLE OF POLICY 29 BOX 1.4 What Constitutes a Foreign Bank Claim? An Overview of the Banking Statistics of the Bank for International Settlements (BIS) A foreign bank claim is a fi nancial claim extended FIGURE B1.4.1 A Taxonomy of Foreign Claims by an international bank (as defi ned in box 1.2) to A + B = International claims a nonresident of the bank’s headquarters country ⎬ ⎭ ⎩ (García-Herrero and Martínez Pería 2007). It typi- cally includes financial assets such as loans, debt A B C securities, equity holdings, and derivatives with posi- Cross-border Local claims of Local claims of tive market values (BIS 2015). At the banking sys- claims foreign affiliates in foreign affiliates in tem level, claim information is available from BIS foreign currency local currency International Banking Statistics through two parallel data sets. A + B + C = Foreign claims Consolidated Banking Statistics (CBS). This data set Source: Adapted from Cerutti, Claessens, and McGuire 2012. measures the consolidated assets and liabilities of Note: The blocks indicate data availability: block A = CBS/UR only; blocks banks headquartered in 31 reporting countries. Intra- A + B and block C = CBS/IC only; block B = unavailable in CBS; and blocks A + B group transactions are netted out using an approach + C = CBS/UR and CBS/IC. CBS = Consolidated Banking Statistics; IC = immedi- ate counterparty; and UR = ultimate risk. similar to that adopted by banking supervision. The CBS disaggregates along two important dimensions. First, it distinguishes between foreign claims booked claims and nonlocal currency claims by local bank by bank offices within counterparty jurisdictions as affiliates). Quarterly stock value series are avail- local claims and those booked outside from global able from 2000 onward, and semiannual data for a or regional headquarters as cross-border claims (see smaller number of countries begin as early as 1983. figure B1.4.1). This approach provides a channel for understanding the sources of foreign credit for indi- Locational Banking Statistics (LBS). The LBS pro- vidual countries and sectors. Second, the CBS reports vides the gross assets and liabilities of banks head- on an immediate counterparty (IC) basis according to quartered in 44 countries. However, unlike the CBS, the residences of the contracted parties, and it reports under principles consistent with balance of payments on an ultimate risk (UR) basis, accounting for risk accounting, it notably does not adjust for intragroup transferalsa to parent entities or third-party guaran- positions. Details in the LBS reveal the location and tors. This kind of reporting reveals the country risk nationality of reporting banks, the residence and sec- exposures of international banks. And these two tor of counterparties,b as well as the currencies and features make the CBS a valuable source of infor- instruments used by banks in transactions. The LBS mation for tracing shock transmissions across bank- is especially useful in understanding the capital flows, ing systems and economies. In addition, the CBS/IC monetary spillovers, and funding risks of banking contains maturity disaggregation for international systems. Quarterly series of amounts outstanding and claims (defi ned as the combination of cross-border adjusted flows are available from as early as 1977. a. Through credit commitments, guarantees, and derivative contracts. b. As of December 2016, LBS information by reporting, parent, and counterparty country was unilateral. has not kept up with the economic growth in financial crisis, followed by a postcrisis drop in developing countries. cross-border claims. Although all regions saw such a drop immediately after the crisis, cross- border claims going to the Latin America and Cross-Border Lending versus Local the Caribbean (LAC) and East Asia and Pa- Lending by Foreign Banks cific (EAP) regions showed a significant recov- Almost all regions witnessed enormous in- ery after this period (panel a, figure 1.4).11 By creases in cross-border claims before the global contrast, the exceptional precrisis increase in 30 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 1.5 What Data Can Be Used to Understand the Activities of International Banks? Data at different levels of granularity offer nuanced the G-SIBs in this sample. These data enable users to details on the evolution of global banking and shed identify the most recent trends in the size and cross- light on bank activities from various perspectives. border activities of global banks and compare global banks from developed and developing countries. Other than regulatory disclosures, financials Transaction-Level Data: Syndicated Bank and ownership information are typically provided Lending in packages, along with rating information, by pri- Syndicated lending is one type of bank credit more vate companies through data services such as Bureau systematically documented in commercially avail- van Dijk Orbis Bank Focus (formerly Bankscope), able data sets. Sources such as Dealogic, Thompson Fitch EM Banking Datawatch, and S&P Global Reuters, and Bloomberg provide the number, volume, Market Intelligence (formerly SNL Financials). Such and currency denomination of syndicated loans, the commercial data sets may cover large samples with country and sector of borrowers, and the identity various degrees of comprehensiveness. Building on and funding shares of syndicate members. Bureau van Dijk Bankscope, two recent statistical efforts identify the nationality of majority owners World Bank FinDebt Database. The World Bank’s and provide insights into the evolution of bank par- Finance and Markets Global Practice constructs ticipation through foreign subsidiaries:c the Global Bond and Syndicated Loan Database (FinDebt) quarterly using Dealogic information. The Foreign Bank Ownership Database. Initially pub- database reports at the borrower sector level syndi- lished as an annex by Claessens and van Horen cated lending volumes, maturities, pricing margins, (2014b), the updated database reveals the national- currency decompositions, and fund uses. A timely ity of direct majority ownership for more than 5,000 source for identifying trends in domestic and cross- banking entitiesd in 138 economies for each year an border bank lending activities, FinDebt provides data entity was active during 1995–2013. Having also on 182 borrower countries as of early 2000.a absorbed information from bank reports, regulatory agencies, monetary authorities, and stock exchanges, Bank-Level Data: Financials and Ownership this comprehensive data set covers more than 90 Structures percent of banking assets in each country’s banking system. It has been applied by researchers seeking to As international bank lending via local affiliates understand the relationship between foreign bank expands, the equity structures of global banks and balance sheets of affiliates become essential elements presence and private credit provision (Claessens and in understanding risk propagation in banking sys- van Horen 2014b), business regulations (Kouretas tems. Although bank-level data are released by regu- and Tsoumas 2016), and the impact of the global lators in specific countries, comparable information fi nancial crisis on banking globalization (Claessens at the international level is limited, except for sys- and van Horen 2015). The Foreign Bank Ownership temically important banks. Database is available publicly. BIS G-SIB Assessment. Following the methodology Bertay, Demirgüç-Kunt, and Huizinga (2017). This identified by the Basel Committee on Banking Super- recent study captures ownership structures from the vision (BCBS), the Bank for International Settlements viewpoint of ultimate shareholders for the period (BIS) publishes 12 indicators in five categories that 2000–15. It maps direct owner and subsidiary links capture the size, interconnectedness, substitutability, onto banking group-level equity networks. The data complexity, and cross-jurisdictional activity of an set identifies more than 2,750 banking groups with annually updated list of global systemically impor- majority-owned affi liates, 325 of which control at tant banks, or G-SIBs (BIS 2013).b This list consists least one foreign bank subsidiary. The data set also of 75 of the largest global banks (BIS 2013), including demonstrates evolutionary trends of bank foreign those from emerging markets in Brazil, China, India, exposure and organizational complexity by linking and the Russian Federation. Notably, bank-level for- subsidiary asset and liability information with that of eign positions not available in the BIS International controlling banks. It provides an alternative perspec- Banking Statistics are disclosed annually by most of tive of country exposures in contrast to those based (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FRAMEWORK, FACTS, AND THE ROLE OF POLICY 31 BOX 1.5 What Data Can Be Used to Understand the Activities of International Banks? (continued) on banking claims, and it reveals intragroup and information derived from more nuanced, confiden- intergroup differences in asset composition, funding tial bank-level reports of counterparty exposures. strategy, operational efficiency, and risk transmission Covering banks from 44 reporting countries (mostly channels among global bank offices. advanced economies, offshore centers, and emerg- ing markets e), this type of information provides broad coverage because the global banking industry System-Level Data: Claims and Liabilities remains geographically concentrated. The informa- The gross and net asset and liability positions of tion revealed on cross-border bank assets and liabili- banking systems are useful from a fi nancial develop- ties is particularly useful for capturing bank flows to ment perspective for cross-country analysis. and from high-income economies. Data challenges remain in addressing global BIS International Banking Statistics. As discussed in banking systemic risk assessments and accounting detail in box 1.4, such information is typically col- for cross-border financial linkages. The IMF-FSB lected and reported by national monetary authorities G-20 Data Gaps Initiative recommends the collec- and reported through the BIS International Banking tion of consistent bank-level data for joint analyses Statistics. Recent studies such as Broner and oth- and continued enhancement of existing aggregate ers (2017) have applied bilateral locational banking statistics. a. FinDebt was accessible only within the World Bank as of December 2016. b. The list of G-SIBs/G-SIFIs (global systemically important fi nancial institutions) was initially published by the Financial Stability Board (FSB) in November 2011 using end-2009 data. Since July 2013, it has been adjusted annually. In the end- 2014 exercise, 30 banks were identified as G-SIBs that are required to meet higher loss absorbency as well as regulatory capital requirements under the Basel III framework (see http://www.bis.org/bcbs/gsib/gsib_assessment_samples.htm). c. Bankscope does not contain information systematically covering foreign branches. Thus bank-level databases exclusively relying on it include foreign bank participation through subsidiaries only. The difference may have important implications, as discussed in chapter 2. d. Including commercial banks, saving banks, cooperative banks, and bank holding companies. e. With the exception of China and Russia. FIGURE 1.3 Lending by International Banks: Foreign Claims on Counterparty Nonbank Private Sector (Country-Level Average by Region) and on Counterparty Sectors (Country-Level Average by Income Level), 2005–14 a. Lending to the private sector b. Counterparty sectoral composition 70 80 % of domestic credit to private sector 60 70 60 by deposit money banks 50 50 % of GDP 40 40 30 30 20 20 10 10 0 0 East Asia Europe and Latin Middle East South Sub-Saharan 2005 2008 2011 2014 2005 2008 2011 2014 and Pacific Central Asia America and Asia Africa High income Developing and the North Africa Caribbean Nonbank private sector Official sector Banks 2005 2008 2011 2014 Sources: Consolidated Banking Statistics (Ultimate Risk Basis); Bank for International Settlements, and International Financial Statistics (database); and International Monetary Fund. Note: Regions exclude high-income countries that belong to the Organisation for Economic Co-operation and Development (OECD). 32 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FIGURE 1.4 Cross-Border Bank Flows: Cross-Border Claims on Counterparty Regions and Foreign Claims on Counterparty Economies by Position Type and Income Level, 2005–15 a. Cross-border claims on counterparty regions b. Cross-border claims versus local claims 800 16 16 4.0 700 14 14 3.5 600 12 12 3.0 Claims (US$, trillions) Claims (US$, trillions) Claims (US$, billions) Claims (US$, trillions) 500 10 10 2.5 400 8 8 2.0 300 6 6 1.5 200 4 4 1.0 100 2 2 0.5 0 0 0 0 05 06 07 08 09 10 11 12 13 14 15 05 06 07 08 09 10 11 12 13 14 15 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 East Asia and Pacific South Asia Cross-border, high income Cross-border, developing Europe and Central Asia Sub-Saharan Africa Local, high income (right axis) Latin America and the Caribbean High-income OECD (right axis) Local, developing (right axis) Middle East and North Africa Source: Consolidated Bank Statistics (Ultimate Risk Basis), Bank for International Settlements. Note: According to the World Bank’s classification, developed countries are defined as high-income countries; the rest of the countries are defined as developing countries. Regions exclude high-income countries that belong to the Organisation for Economic Co-operation and Development (OECD). cross-border claims in the Europe and Central claims over the last few years (panel b, figure Asia (ECA) region did not continue after the 1.4). This difference is also pronounced for crisis, and claims on this region remained more developing countries, where local claims were or less fixed until 2013, when they began to higher than cross-border claims before the fall significantly.12 As of 2014:Q4, total cross- global financial crisis and where local claims border claims by all bank nationalities report- have increased even more than cross-border ing to the BIS Consolidated Banking Statistics claims since the crisis. (CBS) reached $12 trillion on an UR basis, ac- counting for about one-sixth of global bank- New Developments in International ing assets.13 High-income countries received Banking about three-quarters of all cross-border claims in 2014. Foreign bank participation in local markets Proving more resilient to the financial cri- was on the rise in all regions until recently, sis, lending by local foreign banks is now a when some major banks began to retrench more important source of credit than cross- their international operations. In all regions, border lending in both high-income and de- the shares of foreign banks of the total number veloping countries. In high-income countries, of banks increased slightly from 2009 to 2013 cross-border claims, which used to be higher and remained higher than during the precrisis than local claims before the global finan- period (see panel a, figure 1.5). From 1995 cial crisis, fell significantly after the crisis, to 2013, the share of foreign banks increased whereas local claims by foreign affiliates suf- about twofold in the EAP, LAC, and MENA fered much less from the financial crisis, mak- regions and threefold in the ECA region. The ing them more important than cross-border asset shares of foreign banks also increased GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FRAMEWORK, FACTS, AND THE ROLE OF POLICY 33 FIGURE 1.5 Foreign Bank Presence through Subsidiaries: Share of Foreign Banks of Total Banks (Country-Level Average by Region, 1997–2013) and Share of Foreign Bank Assets of Total Bank Assets (Country-Level Average by Region, 2005–13) a. Share of foreign banks of total banks b. Share of foreign bank assets of total bank assets 70 70 60 60 50 50 % of total bank assets % of banks 40 40 30 30 20 20 10 10 0 0 East Asia Europe Latin Middle South Sub- High- East Asia Europe Latin Middle South Sub- High- and and America East Asia Saharan income and and America East Asia Saharan income Pacific Central and the and North Africa OECD Pacific Central and the and North Africa OECD Asia Caribbean Africa Asia Caribbean Africa 1997 2001 2005 2009 2013 2005 2009 2013 Source: Claessens and van Horen 2015. Note: Regions exclude high-income countries that belong to the Organisation for Economic Co-operation and Development (OECD). in all regions before the crisis (panel b, figure information problems because of their short 1.5); but since the crisis the share of foreign cultural and institutional distances and region- bank assets has declined across the board, specific knowledge. On the other hand, the except in East Asia and Latin America.14 In lack of experience and technical know-how, as fact, several major international banks (such well as the probable insufficient prudential and as Deutsche Bank) recently announced plans AML/CFT (anti–money laundering and com- to drastically reduce the number of countries bating the financing of terrorism) regulation in which they operate. Overall, despite this re- and supervision in the home country, may be trenchment in the ECA and SSA regions, for- harmful to economic development and finan- eign banks continue to constitute over 40–50 cial stability. Although internationally compa- percent of the banking industry in both num- rable data on developing country international bers of banks and their asset shares—similar banks are relatively limited, the available evi- to the more resilient LAC region’s foreign dence suggests the rising importance of devel- banking landscape. oping country banks as foreign participants. In some regions, the retrenchment of global Panel a of figure 1.6 shows the large increases banks has been accompanied by an expansion in absolute amounts of foreign claims origi- of regional players, involving a greater variety nating from Brazil, India, Mexico, and Turkey. of players. Indeed, the prospects for interna- The increase mostly stems from the increases tional banking might inspire developing coun- in the foreign claims of banks from Brazil tries to have their own international banks and India, with Turkish and Mexican banks investing regionally or globally. On the one playing a small role. The increases in foreign hand, such South–South international bank- claims of these countries suggest the greater in- ing might offer greater potential to provide ternational involvement of developing country banking services. Developing country banks banks. Indeed, in developing country bank- may be more successful in navigating weaker ing systems, the share of foreign banks owned legal frameworks and solving asymmetric by other developing countries (in terms of 34 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FIGURE 1.6 Rise of South–South Banking: Foreign Claims by Banks in BIS-Reporting Countries (2003–15) and Nationality of Majority Ownership of Banks in Developing Countries (1995–2013) a. Foreign claims by banks of BIS-reporting developing b. Composition of developing country banking systems and developed countries 35 350 100 6 7 Cumulative share in terms of number of banks (%) 8 9 13 16 30 300 14 15 80 19 20 25 23 25 250 Claims (US$, trillions) Claims (US$, billions) 60 20 200 15 150 40 81 78 73 70 10 100 62 61 20 5 50 0 0 0 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 03 04 05 06 07 08 09 10 11 12 13 14 15 20 20 20 20 20 20 20 20 20 20 20 20 20 Domestic Foreign, high income Foreign, developing High-income reporting countries Brazil, India, Mexico, and Turkey (right axis) Sources: Panel a: Consolidated Bank Statistics (Immediate Risk Basis), Bank for International Settlements; and panel b: Claessens and van Horen 2015. number of banks) has increased dramatically, (panel b, figure 1.7).16 This trend suggests that from 8 percent in 2001 to 16 percent in 2013, a handful of banks have become very large whereas foreign banks owned by high-income compared with GDP, possibly leading to sys- countries have fallen to 23 percent from their temic problems in the banking system if one peak of 25 percent during the global financial of them fails.17 The share of foreign banks crisis (panel b, figure 1.6). among the largest banks in developing coun- Banks have also become very large over the tries is rather low (as suggested by panel b, fig- last decade, and most of the largest ones are ure 1.7). Nevertheless, in some regions such as international. During the last decade, but es- ECA and SSA, the assets of the largest foreign pecially leading up to the global financial cri- banks correspond to a sizable 10–20 percent sis of 2007–09, the size of the world’s largest of GDP on average. These banks may be sys- banks increased dramatically (panel a, figure temically important in the host countries but 1.7). From 2005 to 2014, the total size (mea- not necessarily in the home country or for the sured by real total assets from unconsolidated parent bank, which can have important impli- balance sheets) of the world’s largest 10, 50, cations for financial stability and cross-border and 100 banks increased by more than 40 policy coordination. Almost all banks tend to percent (from $14.2 trillion to $20 trillion in hold some foreign assets, but the largest banks the case of the top 10). Interestingly, despite dominate cross-border activities through sub- all the regulatory efforts to curb bank size sidiaries and branches (Buch, Koch, and Koet- and address too-big-to-fail problems, banks ter 2011). Data from the assessment of G-SIBs did not on average contract in size after the by BIS confirm that virtually all the banks in crisis.15 In most regions, the largest banks in- their sample of large banks have significant creased their size not only in absolute terms foreign claims,18 making up on average 23 but also relative to their national economies percent of their total on- and off-balance-sheet when compared with the precrisis period exposure. These figures suggest that bank size GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FRAMEWORK, FACTS, AND THE ROLE OF POLICY 35 FIGURE 1.7 Total Assets of Largest Banks (Absolute Amounts, on a Rolling Basis) and Size of Assets in Relation to National Economies (Combined Assets of Top Five Banks, Country-Level Average by Region), 2005–14 a. Assets, absolute amounts b. Assets of top five banks relative to GDP 140 80 120 70 Assets (2010 US$, trillions) 60 100 Share of GDP (%) 50 80 40 60 30 40 20 20 10 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 05 09 13 05 09 13 05 09 13 05 09 13 05 09 13 05 09 13 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Top 10 Top 50 Top 100 Top 500 Top 1,000 East Asia Europe Latin Middle South Sub- and and America East Asia Saharan Pacific Central and the and North Africa Asia Caribbean Africa Foreign Domestic Sources: Bureau van Dijk Bankscope (database); and World Development Indicators (database). Note: Panel b indicates asset decomposition on an unconsolidated basis. Regions exclude high-income countries that belong to the Organisation for Economic Co-operation and Development (OECD). should be a central issue in any discussion of FIGURE 1.8 Regulatory Restrictions on Foreign international banking. Bank Entry and Ownership (Country-Level Average), 2000–11 Many countries, including many develop- ing countries, have increased their restrictive policies on international banking. Regulatory 4.0 4.00 4.00 and supervisory restrictions on foreign bank entry may reduce bank competition, leading 3.90 Index, 0–4 (with 4 being least restrictive) 3.9 to inefficiencies, inferior capital allocation, and a slower pace of economic develop- 3.8 ment. Figure 1.8 presents an index proxying 3.74 3.72 3.71 restrictions on foreign bank entry and rates 3.7 of license application denials over the period 2000–11. In both developed and develop- 3.61 3.6 ing countries, foreign bank entry was easier 3.56 during the first half of the 2000s than dur- 3.5 ing the second half, which includes the global financial crisis. A recent survey by Ichiue 3.4 and Lambert (2016) on postcrisis interna- 2000 2003 2007 2011 2000 2003 2007 2011 tional banking regulation also reveals tighter High-income countries Developing countries regulation of international bank activities in both home and host countries (and espe- Source: Barth, Caprio, and Levine 2013. cially in developed economies) from 2006 to Note: The index of foreign bank entry and ownership captures restric- tions on foreign bank entry to a market through four channels: acquisi- 2014. Other recent policy changes, including tions, subsidiaries, branches, and joint ventures. At the country level, the macroprudential policies (such as increased index is equal to four minus the number of restricted channels. 36 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 capital requirements or discriminatory reserve these companies, information sharing, super- requirement ratios) and ring-fencing of for- vision, and joint assessment of “systemically eign bank subsidiaries, may also restrict inter- important” fintech firms will be important national banking activities (Claessens 2016). tasks for regulators. All in all, various regulatory actions after the global financial crisis have led to de jure and POLICY IMPLICATIONS de facto restrictions on international banking activities. This is also reflected in the reduc- Overall, efficient allocation of resources is tion of entry after the crisis. Indeed, although key to economic development, and interna- the number of foreign banks exiting markets tional banks can play an important role in has remained more or less the same, there was introducing competition and improving the much less entry after the crisis, and net entry efficiency of the financial system. In addition, became negative for the first time since 1995. international banking can act as a risk-sharing A recent factor in the global banking land- scheme, smoothing downturns by sharing scape is the new financial technology (fintech) them among home and host countries. Risk firms. Fintech refers to technology-enabled sharing implies greater financial inflows and financial innovation facilitating new prod- outflows for host markets, but it should sta- ucts, services, and business models. After bilize the local credit supply overall. Neverthe- the global financial crisis, low interest rates less, a country’s experience with international and the departure of traditional banks from banks tends to depend on the characteristics some specific segments created opportunities of those banks as well as the country’s insti- for fintech firms to disrupt the traditional fi- tutional and regulatory environment, implying nancial intermediation process. Although the that policy can play a crucial role in shaping size of these firms is currently negligible com- this experience. The global financial crisis pro- pared with that of traditional banks, the ser- vided crucial insights into the importance of vices they provide can result in competition in international banking for economic develop- many lines of bank business. Indeed, digital fi- ment and financial stability, confirming the im- nancial services lead to cost reductions and to portance of heterogeneity of impact based on better capture of new market segments, and differences in home and host country policies. therefore greater financial inclusion. Many The benefits and costs of international traditional banks have already acknowledged banking are two sides of the same coin, imply- these prospects and have begun to work with ing that good policy making is very important fintech firms, focusing on complementarities in ensuring that developing countries benefit or pursuing new digital technologies in house from international banking. The challenge of (see chapter 3). From peer-to-peer (P2P) lend- policy is to maximize the benefits of bank in- ing practices to payment services, many of ternationalization while minimizing the costs the areas in which fintech firms operate have and making international banking a reliable natural international extensions. For exam- component of the global financial system for ple, crowdfunding microloans to households developing countries. Cross-border regulation, or groups in developing countries saves the supervision, and resolution mechanisms; legal, valuable capital of MFIs such as Kiva.org, information, and other institutional frame- and cross-border, P2P money transfer services works; and competition policy in the financial (such as TransferWise) reduce the cost of sector, including entry regulations—all can sending remittances to developing countries. be designed with an eye toward minimizing If successful, fintech firms will pose various the costs and maximizing the benefits of bank challenges for regulators worldwide. There globalization. Finally, two new trends—the will be cross-jurisdictional concerns because increasing South–South activity by interna- fintech firms largely work globally, and it is tionalizing developing country banks and not clear which country’s laws would be ap- the potential of technological advances and plied to them. To achieve coordination among fintech to modify global banking—present GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FRAMEWORK, FACTS, AND THE ROLE OF POLICY 37 new challenges. We turn to these in the next 9. The pattern looks similar when examining chapters. data for all countries, not just developing ones. Here, the value of foreign syndicated NOTES loan issuances was $2.5 trillion in 2006 and $3.0 trillion in 2015. The total value of 1. Large domestic banks may receive funding global cross-border bond issuances was $3.2 from international capital markets to supply trillion in 2006 and $3.8 trillion in 2015. The credit to firms and households. Yet they may proceeds from initial public offerings (IPOs) still lack the necessary risk management tools globally were about $0.8 trillion in both or corporate governance practices, or they 2006 and 2013, according to the “Global may behave politically if they are state-owned Equity Capital Markets Review” by Reuters (Dinc 2005), channeling funds to less efficient (2014). firms and ending up with lower profits and 10. The BIS data contain information on the posi- higher costs than foreign banks (Micco, Pan- tions of banks, which include other financial izza, and Yañez 2007). They may also not be assets such as debt securities and equity hold- able to roll over debt in the case of domes- ing on top of loans. The series can be used as tic turmoil (see Schnabl 2012), such as when a proxy for international bank lending (see, internationally funded domestic banks cut for example, Cetorelli and Goldberg 2011). credit more than foreign banks. 11. These series look quite similar (except their 2. This may especially be severe when a lack magnitudes are smaller) when the BRICS of an information infrastructure prohibits countries (Brazil, Russia, India, China, and domestic banks from reaching SMEs and the South Africa) are excluded—they are the larg- poorest households. In such an environment, est receivers of cross-border funds. The only even if domestic banks move down the mar- exception here is the South Asia (SAR) region, ket, that may be another example of excessive in which almost all cross-border claims go to risk taking causing problems in the future. India. 3. Jeon and others (2016) show that domestic 12. During the global financial crisis, the ECA bank risk taking increases as the foreign bank region acted as a laboratory for international presence increases in a developing country banking activities because of high foreign setting. bank involvement. This experiment provided 4. See Goldberg (2009) for an overview. 5. For example, in the early 2000s (2001–04) lessons for other countries, which are detailed international banks played an important role in chapter 2. in expanding credit in economies in Central 13. Here, global assets include those of deposit and Eastern Europe (Enoch 2007), leading in money banks, which are restricted to deposi- some cases to excessive credit booms (Duen- tory institutions such as commercial banks, wald, Gueorguiev, and Schaechter 2005). credit unions, savings institutions, and money 6. Boom/bust cycles similar to those in the tra- market mutual funds, according to definitions ditional banking sectors may also apply to in the International Financial Statistics of the microfinance institutions in developing coun- International Monetary Fund. The World tries (Wagner 2012). Bank’s Global Financial Development Data- 7. According to Wu, Luca, and Jeon (2011), base indicates that by 2013:Q4, total assets compared with domestic banks, foreign owned by deposit money banks stood at banks are less responsive to host monetary $72.3 trillion. policy shocks, weakening lending chan- 14. The difference between increases in the share nels in emerging economies. Wu, Lim, and of number of foreign banks and in the share Jeon (2016) provide similar evidence for the of foreign bank assets indicates domestic Republic of Korea, emphasizing that foreign banking consolidation in some regions. bank branches rather than subsidiaries drove 15. The total asset size of the 10 largest banks the results during the global financial crisis. in 2013 was virtually the same as in 2007, 8. See Smith, Walter, and DeLong (2012) for although the list consists in part of different a general outlook on the activities of global banks. banks, which include bond and equity issu- 16. Percentage increases in the assets of the larg- ance, wealth management, advisory or pay- est five banks with respect to national econo- ment services, and trading. mies are higher in many regions (specifically, 38 FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF POLICY GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 the ECA, LAC, MENA, and SSA, and high- try—are associated with various bank charac- income OECD countries) than the asset teristics such as risk and return, activity mix, growth of the remaining banking systems, and funding strategy. They show, for example, relative to GDP. that banks with a larger systemic size have 17. Furthermore, the absolute and systemic size lower returns on assets without necessarily of banks could have consequences for their having lower risk as measured by the z-score, business models and funding structures. Ber- whereas those with a larger absolute size have tay, Demirgüç-Kunt, and Huizinga (2013) higher returns on assets without necessarily analyze how absolute size—measured by real having high risk as measured by the z-score. total assets—and systemic size—measured by 18. The term used in the assessment templates is total assets over the GDP of the home coun- cross-jurisdictional claims. CHAPTER 2: KEY MESSAGES • Foreign banks, through their brick-and-mortar operations, have the potential to improve the performance of local banks as well as the degree of competition in the local banking sector and the overall access to credit in the host economy. These benefits are more likely to mate- rialize when the proper regulatory and supervisory frameworks are in place in both the host and home countries, and when financial liberalization is accompanied by institutional reforms that strengthen the information environment and contract enforcement of the host economy. • Although foreign banks can help smooth credit flows during local financial crises, they also can import shocks from abroad. Cross-border cooperation between authorities from both the home and host countries can help minimize the propagation of shocks. In addition, host economies can opt to allow the entry of foreign banks from home countries with stricter bank • Financialor regulations, systems are multidimensional. to diversify the roster of foreign Four characteristics banks by the home arecountry of particular interest in order to miti- for benchmarking fi nancial systems: fi nancial gate the impact of shocks from a specific country. depth, access, effi ciency, and stability. These characteristics need to be measured for financial institutions and markets. • The composition of foreign banks is evolving rapidly. Since the global financial crisis, most • Financial bank systems exits have been come in all by banks withshapes and sizes,in headquarters and differ widely high-income in terms countries, of the four whereas South– characteristics. As economies develop, services South entry has been increasing and greater regionalization in the roster of foreign tend provided by fi nancial markets bankstohas become more important than those provided by banks. been observed. These trends could affect who gets credit because South–South banking may be better • The at overcoming global the was financial crisis challenges lending of about not only to the smaller financial andIn instability. more some informationally economies, opaque clients the crisis wascommon in developing associated countries. with important Nevertheless, changes in financial greater depth South–South and access. banking may also entail additional risks from hosting foreign banks from less regulated and institu- tionally weaker home countries. • More intensive cooperation is needed between home and host countries, going beyond in- ternational agreements and the exchange of information. Under the current cooperation ar- rangements, host country authorities have limited ability to properly supervise international banks, and supervisors from home and host countries do not fully consider the effects of their decisions beyond their borders. • New technologies in the finance area are bringing new competitors and altering the way banks do business. These changes are likely to impact access to financial services as well as the efficiency and stability of the financial sector. Financial technology can increase access and improve the delivery of financial services, thereby reshaping competition among financial pro- viders. Large international banks that can afford to increase investment in research and de- velopment are likely to play an important role in this area. A key challenge for policy makers will be to closely monitor the risks of a new, rapidly developing industry without hindering its potential. B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 2 Brick-and-Mortar Operations of International Banks n extensive body of literature is de- the entry of foreign banks helped them restore A voted to studying the role of foreign banks in the domestic banking sectors that host their brick-and-mortar operations financial intermediation. Moreover, the for- eign banks that were already present in those countries (again, largely the affiliates of par- and their impact on local bank competition, ent banks in developed countries) were often financial stability, and access to credit. The able to help stabilize the credit supply. bulk of the research published from the late A wider reading of the literature, especially 1980s to the early 2000s found that a foreign in light of new research since the global fi- bank presence had generally positive effects nancial crisis and euro area crises, makes it on banking sector competition, efficiency, and clear that international banking has always stability, with more mixed results on access to been accompanied by both risks and oppor- credit. But this generally positive assessment tunities. The balance between benefits and was, at least in part, a reflection of the types costs has depended on the roster of foreign of banks that chose to go abroad during this participants, the health of their home country period—that is, they were mostly well-estab- banking sectors, and, perhaps most impor- lished banks from developed countries. And tant, the institutional and legal environments their effects on domestic banking sectors de- pended crucially on the extent of development of the host country. Global evidence indicates of the host country’s banks, with greater gains that the relationship between the presence of in competition and efficiency in host countries foreign banks and private credit levels is nega- with less developed banking sectors. Indeed, tive in low-income countries and in countries foreign banks found it much harder to com- where contract enforcement is costly and ac- pete effectively when entering many developed cess to credit information is limited (Claessens countries (Berger and others 2000; Chang, and van Horen 2014b). Hasan, and Hunter 1998; DeYoung and Nolle New evidence also reveals that a foreign 1996; Hasan and Hunter 1996; Miller and bank presence fosters higher rates of busi- Parkhe 2002; Peek, Rosengren, and Kasirye ness formation, but that these effects are 1999). Also, banking crises generally ema- much stronger in economies with tougher le- nated from less developed host countries, and gal enforcement. Foreign bank entrants from GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 41 42 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 developed economies are especially dependent regulatory and supervisory framework, ac- on strong legal frameworks to foster busi- companied by institutional reforms that ness formation (Alfaro, Beck, and Calomiris strengthen the local banking sector and thus 2015). Further findings indicate that the com- prevent foreign banks from capturing enough petitiveness of the domestic banking sector at market power to force out domestic banks the time of liberalization affects how domes- (Demirgüç-Kunt, Beck, and Honohan 2008). tic banks respond to the added competitive As for institutional factors, host countries pressures imposed by foreign banks. Post- should improve their information environ- liberalization gains in the aggregate supply of ment and the quality of contract enforcement, credit, increases in growth, and declines in the which can enable foreign banks to further volatility of growth are more likely to occur if develop the domestic banking sector. Host countries have domestic banking sectors that country authorities can also minimize the are already relatively competitive (Behn and risks associated with foreign bank participa- others 2014). tion, by, for example, having their regulators The impact of foreign banks on banking strive for a diversified roster of foreign banks, sector stability clearly depends on financial which would limit the exposure to shocks conditions in the countries in which their par- from a particular country. ents are headquartered as well as the condi- Regulators should also be aware of the tions in the banking sector of the countries increase in South–South banking. Although that host them. International banks can offer the overall levels of foreign presence have re- the host economy a risk-sharing arrangement mained steady since the global financial crisis, in which, on the one hand, they can help to the composition of foreign banks is chang- stabilize credit flows during local crises, while ing. The network of foreign bank subsidiaries on the other hand, they may more easily from emerging markets and developing econ- spread foreign shocks to the local economy omies operating in other developing countries (Chava and Purnanandam 2011; Morais increased substantially over the last decade and others forthcoming; Peek and Rosengren (map 2.1). Banks from developing countries 1997, 2000; Schnabl 2012). Nevertheless, evi- represented about two-thirds of the new en- dence suggests that the transmission of shocks tries postcrisis, and banks from high-income varies substantially across foreign banks, and member countries of the Organisation for it is greatly influenced by conditions in the Economic Co-operation and Development home and host countries, as well as the char- (OECD) were responsible for most of the ex- acteristics of the parent bank (Buch and Gold- its from markets (Claessens and van Horen berg 2015). In the wake of the global financial 2015). Greater South–South entry has also crisis, the differing business strategies pursued coincided with regionalization in the roster of by foreign banks implied that not all of them foreign banks in many host countries (Claes- responded to financial shocks in the same way. sens 2016). These trends could affect who Even in emerging Europe, which was hard-hit gets credit. For example, a foreign bank pres- by the crisis, a number of large foreign banks ence is more strongly linked to higher rates remained committed to their host countries, of business formation when those banks are in effect treating them as a second home mar- headquartered in developing countries, al- ket (Bonin and Louie, forthcoming). though banks from developing countries are The impact of foreign banks largely de- mainly able to spur business formation in in- pends, then, on the actions taken by the host dustries characterized by simpler production country before and after financial liberaliza- processes, where agency conflicts are lower tion. On their own, foreign banks are no (Alfaro, Beck, and Calomiris 2015). However, panacea for guaranteeing financial develop- South–South banking may also bring addi- ment and stability. Host countries should, tional risks in terms of stability because the therefore, aim to create the conditions needed home economies of the new foreign banks are to reap the benefits of international banking. more likely to have weaker institutional envi- Regulators should adopt a strong financial ronments and more lax regulations. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 43 Alternative delivery mechanisms are an- MAP 2.1 South–South Banking Subsidiary Networks, 2005 and 2014 other aspect to monitor closely because they a. 2005 are reshaping who has access to banking services, and foreign banks are likely to play an important role in providing those ser- vices. In principle, digital financial services, and in particular those provided via mobile telephony, hold the promise of deepening financial inclusion to market segments that have been underserved (Ahmed and others 2015; Demirgüç-Kunt and Klapper 2012). But even though deeper financial inclusion likely improves household welfare, it also exposes newly served households and firms to risks, mainly in the credit market, which could have implications for overall financial b. 2014 stability.1 More broadly, financial technol- ogy (fintech) is likely to affect the way banks compete with each other (and other non- bank providers of financial services) for all market segments, which could again have implications for access, efficiency, and finan- cial sector stability. The greater regionalization in foreign bank presence and the increasing reliance on alternative delivery mechanisms for digi- tal banking services will pose challenges for bank regulation and supervision. Responsibil- ity for the supervision and resolution of the Source: Visualization based on Bertay, Demirgüç-Kunt, and Huizinga 2017. affiliates of international banks is a burden Note: The maps show the location of foreign bank subsidiaries to and from developing countries. The connections reflect majority ownership. largely borne by the host countries. Greater regionalization in foreign bank participation could open the door to more effective coop- eration and information sharing between su- to credit—but through the lens of the recent pervisors across host countries. But a general developments and trends just described. The supervisory approach—as dictated by, for chapter closes with a review of the most re- example, the Basel Committee on Banking cent cross-border approaches to supervising Supervision—could be poorly suited to some and regulating international banks and a se- countries, especially in light of the substantial ries of recommendations for policy makers. increases in South–South foreign bank entry.2 The regulation of nonbank providers of digi- DETERMINANTS OF FOREIGN tal financial services also remains an impor- BANK ENTRY tant challenge. The remainder of this chapter is structured By identifying the factors that drive foreign as follows. It begins with a discussion of the banks into a host economy, regulators can conditions and drivers that determine the en- better assess ways to attract international try of foreign banks in an economy. It then banks. The banking sectors of many develop- discusses three standard aspects of the perfor- ing countries and emerging economies have mance of foreign banks and their influence on experienced a significant increase in foreign host country banking sectors—competition bank entry since the 1990s (Cull and Mar- and efficiency, financial volatility, and access tínez Pería 2010). The experiences of financial 44 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 liberalization have differed greatly from coun- International Diversification try to country, and they have increased under- standing of the factors that attract foreign Benefits from prospective diversification are banks to a host economy. Overall, foreign also among the most important motivations banks expand abroad to pursue profitable for bank internationalization. The literature opportunities by either following their home on portfolio optimization in an international customers or seeking new clients. Expand- setting dates back to the late 1960s, but only ing abroad also allows them to diversify their during the last decade have researchers begun business. However, the entry of foreign banks looking at the benefits of international diver- is greatly dependent on the information en- sification in banking. Hayden, Porath, and vironment of the host country. Thus, foreign Westernhagen (2007) find evidence that such banks find it easier to operate in countries in diversification tends to be associated with re- which the proper mechanisms to reduce the ductions in German banks’ returns, even after information costs of doing business abroad controlling for risk, whereas García-Herrero are in place. Barriers to entry and restrictions and Vázquez (2013) suggest that the risk re- on the operations of foreign banks also mat- turn gains from the foreign subsidiaries of ter. This section reviews these drivers in more international banks from eight high-income detail. countries are potentially substantial and not entirely exploited. Buch, Driscoll, and Oster- gaard (2010) compute optimally diversified Following Home Country Customers and international asset portfolios for banks us- Profit Opportunities in Host Countries ing the mean-variance portfolio model and Two of the main reasons that foreign banks compare them with the actual cross-border expand abroad are to follow their interna- asset positions of banks to show that there tional clients and to seek new profit oppor- are effective impediments to international tunities in host countries. Studies from the diversification. 1990s found that foreign banks are more likely to enter host economies with higher for- Entry Barriers and Other Restrictions eign direct investment (FDI) from or higher bilateral trade with their home country in Barriers and regulatory restrictions are impor- relation to other countries, which is indi- tant determinants of foreign bank entry. In the rect evidence that banks follow home clients last few years, several studies have deepened across borders.3 Using granular data, Seth, understanding of how the entry decisions of Nolle, and Mohanty (1998) document that a banks may be motivated by cross-country dif- substantial fraction of the lending of foreign ferences in banking regulation. A few theo- banks operating in the United States goes to retical papers in the 2000s tried to model clients from their home countries. Other stud- the “race to the bottom” in the presence of ies, however, also show that foreign banks are regulatory arbitrage opportunities. Acharya interested in expanding their business to new (2003) shows, in a two-economy model of clients. Analyzing the international location financial integration, how more regulatory choices of Japanese banks, Yamori (1998) forbearance in one country induces banks confirms that these banks have pursued lo- to assume more risk abroad. This factor re- cal banking opportunities in host countries. duces the competitive advantage of banks in Indeed, some cross-country studies have posi- countries with less forbearance, and, because tively related a host country’s economic activ- it forces some banks to exit the market, the ity and financial depth to higher foreign bank regulators of these countries adopt greater participation (Focarelli and Pozzolo 2000), forbearance.4 The empirical evidence suggests suggesting that international banks look for that regulatory differences in both home and profitable markets when making their inter- host countries influence cross-border bank nationalization decisions. mergers and acquisitions (M&As) and lead to GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 45 a reallocation of international banks’ activi- abroad also finds evidence that regulation in ties. Karolyi and Taboada (2015) and Dong, the host country relative to the home country Song, and Tao (2011) find that cross-border matters for location decisions. Using a bank- acquisitions primarily involve acquirers from level data set of the most active American countries with more regulation, and that the banks operating in 82 foreign countries from takeover premium tends to increase for banks 2003 to 2013, Temesvary (2015b) shows located in less regulated countries. Analyzing that U.S. banks are more likely to open sub- the European context, Carbo-Valverde, Kane, sidiaries in host economies with laxer capital and Rodriguez-Fernandez (2012) find evi- requirements and disclosure rules and where dence validating the hypothesis of a race-to- banking activities are less restricted than those the-bottom form of arbitrage. However, in a in the United States. Similarly, the closure of similar context, Hagendorff and others (2012) U.S. banks abroad is more likely to occur if find contradictory results, in that less regula- the host economy has stricter deposit insur- tion in the host country does not mean that ance schemes and more restrictions on bank bidders are willing to pay a premium for less activities than those in the United States. As regulated regimes. A more recent study that box 2.1 further discusses, the legal structure of analyzes the activities of U.S. banks operating foreign banks is also influenced by regulation. BOX 2.1 How Do Banks Expand Abroad? Branches or Subsidiaries? In practice, there are two different ways in which ments and corporate taxes, are crucial in the choice international banks can expand abroad: as subsidiar- of operation of cross-border banks. Based on their ies or as branches. analysis of a database on the operations of cross- Branches are legally integrated with the par- border banks in Latin America and Eastern Europe, ent bank. Capital requirements are generally waived Cerutti, Dell’Ariccia, and Martínez Pería (2007) pro- because the parent bank remains responsible for vide evidence of the importance of these elements. the regulation and the liabilities of its operations in They fi nd that foreign banks are less likely to operate the host country. Deposits tend to be insured by the as branches in countries that limit fi nancial activities deposit insurance agency of the foreign bank’s home or when there are barriers to the entry of new banks. country. Subsidiaries entail setting up or acquiring a They are more likely to open branches in host coun- separate legal entity, and thus they tend to operate like tries with high corporate tax rates or where foreign independent foreign banks. They are capitalized sepa- operations are smaller. rately, they are subject to host country regulation, their Many of the factors that affect entry decisions deposits can be insured by the host country’s deposit can be seen as forms of ex ante ring-fencing on the insurance agency, and they can even fail separately part of host countries. Ring-fencing refers to the from their parent bank (Calzolari and Loranth 2011).a geographical separation of part of a cross-border In both scenarios, the host country authorities banking group from its parent institutions or other should exchange relevant information with the home affiliates—an approach that aims to protect domestic country authorities because the banking group is reg- financial markets, but typically makes a host market ulated and supervised on a consolidated basis. Fiech- less attractive to multinational banking groups.b Ex ter and others (2011) point out that under the home– ante ring-fencing often takes the form of higher capi- host supervisory accord of the Committee on Banking tal or liquidity requirements, tighter dividend restric- Supervision, the responsibilities of host countries are tions, and limitations on liquidity flows. far greater for subsidiaries, whereas home countries More generally, although host country regulatory have much greater control over branches. authorities may have strong incentives to impose ex Several factors, such as the levels of legal restric- post ring-fencing measures—for example, to preserve tions on their operations as well as entry require- banking sector liquidity after the onset of a crisis— (box continued next page) 46 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 2.1 How Do Banks Expand Abroad? Branches or Subsidiaries? (continued) these measures should be distinguished from the ex- Studies suggest that the mode of entry of foreign ante measures that are likely to affect the mode of banks can also affect credit procyclicality. Alber- operation of cross-border banks and thus the struc- tazzi and Bottero (2014) analyze the contraction of ture of the banking sector. credit of Italian banks during the collapse of Lehman The factors that lead foreign banks to enter as Brothers, and fi nd that the difference in the contrac- either a branch or a subsidiary have implications tion of credit between foreign and domestic banks for their subsequent performance and thus poten- was mainly explained by the credit contraction of tial implications for how they should be regulated branches, rather than subsidiaries, of foreign banks. and supervised. For example, Danisewicz, Rein- However, the legal structure of foreign banks hardt, and Sowerbutts (2015) fi nd that following cannot by itself protect banks from systemic shocks. a tightening of capital requirements in the home When the global financial crisis hit, contagion in countries of their parents, branches of international some countries happened very quickly, no matter banks reduce the growth of their interbank lend- how the foreign operations were legally organized. ing by 6 percent more relative to subsidiaries of Iceland, for example, had structured its foreign oper- the same banking group. This result suggests that ation using both subsidiaries and branches, and the when a branch operates within the capital require- detrimental impacts were similar, no matter how the ments of its parent, it cuts lending activities in the activities of foreign banks in Iceland were organized. host country significantly in response to an increase This experience provides potentially important les- in the capital requirement in the home country of sons for emerging market supervisors because it indi- the parent bank. As a result, a policy change in the cates that the fi nancial, operational, and reputational home country will affect the host country differ- ties between home and host operations can over- ently, depending on the legal structure of the foreign ride legal and ownership structures in governing the operation. responses of foreign banks to a crisis. a. See Hoggarth, Hooley, and Korniyenko (2013) and Fiechter and others (2011) for detailed explanations. b. A report by the International Monetary Fund (IMF 2015a) emphasizes the perspective of the regulator rather than that of the banking group, defi ning ring-fencing as “measures imposed by prudential supervisors with the objective of protecting the domestic assets of a bank so they can be seized and liquidated under local law in case of failure of the whole or part of an international banking group.” See also D’Hulster and Ötker-Robe (2015) for a detailed explanation of ring-fencing. More evidence is provided by research look- a level playing field in international bank regu- ing at how global banks tend to reallocate their lation (such as the Basel Accords). Morrison activities between domestic and international and White (2009) show theoretically, how- locations when regulation tightens. According ever, that such efforts are not without cost; to Ongena, Popov, and Udell (2013), in Eu- the better-regulated economy suffers in favor rope foreign banks incur greater risk abroad of the weaker one, but multinational bank- when bank regulation and supervision in the ing helps to reduce the damage. Nevertheless, home country tighten, suggesting that they try harmonizing and enforcing effective regulation to compensate for a lower charter value or a and supervision across countries with different restriction on certain risky activities at home. incentives and degrees of financial, legal, and Aiyar, Calomiris, and Wieladek (2014) and economic development have proved to be ex- Danisewicz, Reinhardt, and Sowerbutts (2015) tremely difficult. This was particularly evident obtain similar results in the context of the in the recent global financial crisis. United Kingdom. Meanwhile, regulatory arbi- Since the crisis, although entry has not trage could conceivably be curbed by adopting generally been restricted, the activities of GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 47 foreign banks have been curtailed. As dis- is, whether banks have to be large to compete cussed in more detail in the last section of in international markets. They test their hy- this chapter, other, sometimes more informal pothesis using microdata within the universe measures have been adopted to limit the influ- of German banks and learn that only the larg- ence of cross-border financing as a response est and most productive banks have a com- to the financial crisis. Common measures mercial presence abroad. This finding con- that countries have adopted are macropru- firms the importance of scale in international dential policies, countercyclical buffers, or operations. However, in contrast to the pre- even ring-fencing in an effort to constrain dictions of recent trade models, the smallest capital flows (box 2.2). Meanwhile, the regu- banks also hold foreign assets, and some un- lation and supervision of global banks have productive banks have an international pres- become stricter and more intense. These in- ence. Galema, Koetter, and Liesegang (2016) creased restrictions may induce global banks focus on relative cost advantages instead, and to shift their activities to other countries (Ber- find that less profitable, riskier, and larger lin 2015) or to replace activities regulated at banks are more likely to operate abroad. the host country level with those regulated at Financial safety nets may also play a role in the home country level (Temesvary 2015a). banks’ internationalization decisions because In general, the arbitrage practices revealed in home country authorities may be less likely to different studies highlight the challenges pre- intervene when the bank holds considerable sented by cross-country differences in bank- international assets. Bank size in both absolute ing regulation and the need for international and systemic (relative to national economies) coordination to regulate and supervise the ac- terms affects the market discipline applied tivities of international banks. to a bank. This market discipline, which can High fixed costs may be a barrier to entry be defined as the response of depositors, or for some banks, depending on their size and more broadly bank funding costs, to changes productivity. Buch, Koch, and Koetter (2011, in bank risk, depends on the strength of the 2014) investigate theoretically and empirically financial safety net (that is, the capacity of whether the size pecking order documented national economies to bail out banks in trou- for manufacturing firms in the international ble). Thus banks that are too large systemi- trade literature holds for global banks—that cally, especially in countries suffering public BOX 2.2 Macroprudential Policies to Manage Credit Growth Cerutti, Claessens, and Laeven (2015) examine the developing economies. Finally, limits on foreign cur- effect of macroprudential policies on credit growth rency lending are negatively related to credit growth in 119 countries from 2000 to 2013. They fi nd that in all countries, but especially in emerging markets emerging economies are more likely to adopt such and developing economies. The patterns suggest policies than others. Although borrower-based that macroprudential policies can help countries macroprudential tools such as limits on loan-to-value manage financial cycles, though the evidence also and debt-to-income ratios are associated with slower indicates that they are more effective in boom than credit growth in all countries, the relationship is stron- bust phases. These policies are also associated with ger for developing countries. Similarly, institution- increased cross-border lending, suggesting that some based tools such as dynamic provisioning, limits on lending that would otherwise occur in host countries leverage, and countercyclical capital requirements is diverted to avoid them. are negatively associated with credit growth in 48 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 deficits, can be too big to save and therefore discipline via increased funding costs—a re- are subject to more intense market discipline sult that is especially driven by banks in coun- (Demirgüç-Kunt and Huizinga 2013). tries with large public deficits. Financial safety nets, and more specifi- cally the incentive for national authorities to Conditions That Mitigate Asymmetries bail out a bank in trouble, can also be related of Information to bank internationalization because cross- border resolution proved to be problematic Geographical, cultural, and institutional dis- during the recent crisis period. Beck and oth- tances are important determinants of banks’ ers (2013) develop a model that they then entry decisions because they affect informa- test in the data, highlighting the incentives tion asymmetries. Buch (2003) reveals how that national authorities have to intervene information costs, proxied by geographical in a troubled cross-border bank. Because in- distance and cultural and legal system simi- tervention is costly and national supervisors larities, drive the international investment are mainly interested in protecting domestic decisions of banks.5 Moreover, van Horen stakeholders, the incentives for intervention (2007) suggests that developing country for- are stronger if the share of domestic assets eign banks are more likely than their devel- and deposits is high. Likewise, if the share of oped country counterparts to invest in small domestic bank equity is high, the incentives developing countries with weak institutions, to intervene will be low because the national suggesting a role for institutional proximity.6 authorities will align with the interests of These results may help shed light on the re- domestic shareholders, who will prefer to let cent trends in international banking, where the bank continue operating and avoid the the entry of foreign banks from developing costs of bank failure. In line with the finan- countries into other developing economies cial safety net and distorted incentives of na- has been steadily increasing. One example, tional authorities’ arguments, Bertay, Demir- outlined in box 2.3, is Ecobank, an African güç-Kunt, and Huizinga (2016) show that bank that has expanded its operations across internationalizing banks face greater market more than 30 countries in Africa. BOX 2.3 Foreign Banks in Africa: The Case of Ecobank The banking industry in Africa has traditionally among the lowest globally (Nyantakyi and Sy 2015). been dominated by European banks because of its Meanwhile, the synergy of fi nancial liberalization economic and legal legacies. Over the last decade, the and postcrisis retrenchment of European banks have rise of South–South banking has gained importance induced the international expansion of Sub-Saharan globally, and it has significantly affected fi nance in banks within the region (Honohan and Beck 2007; Sub-Saharan Africa (Beck, Fuchs, and others 2014). Moyo and others 2014). Such developments have Compared with developing countries elsewhere, opened up possibilities for enhancing banking sector Sub-Saharan economies tend to be characterized by competition, deepening fi nancial systems, and wid- shallower and less efficient fi nancial systems (Hono- ening financial access. han and Beck 2007) that offer relatively limited basic Ecobank Transnational Incorporated, or Ecobank, services (Beck and Cull 2013). Based on common is an example of regionalization by an African bank fi nancial access and depth measures, access to tra- during the last two decades, highlighting both the ditional banking services in West and East Africa is opportunities and risks related to South–South bank- (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 49 BOX 2.3 Foreign Banks in Africa: The Case of Ecobank (continued) FIGURE B2.3.1 Distribution of Ecobank’s Branches and Offices (2015) and Assets (2011 and 2015) a. Branches and offices, 2015 b. Assets 2011 7.5 4.7 2.2 2.4 3.3 285 512 150 2015 9.2 7.1 2.6 4.3 2.3 292 0 5 10 15 20 25 30 Assets (US$, billions) Nigeria UEMOA AWA CESA Nigeria UEMOA AWA CESA Parent Source: Ecobank 2017. Note: The geographical regions are classified according to Ecobank: UEMOA (West African Economic and Monetary Union), Benin, Burkina Faso, Cabo Verde, Côte d’Ivoire, Guinea Bissau, Mali, Niger, Senegal, and Togo; AWA (Anglophone West Africa), The Gambia, Ghana, Guinea, Liberia, Sierra Leone; CESA (Central, Eastern, and Southern Africa), Burundi, Cameroon, the Central African Republic, Chad, Democratic Republic of Congo, Equatorial Guinea, Gabon, Kenya, Malawi, Mozambique, Republic of Congo, Rwanda, São Tomé and Príncipe, South Sudan, Tanzania, Uganda, Zambia, and Zimbabwe. ing. Founded in 1985 when foreign- and state-owned cial centers such as Paris, Beijing, Dubai, Johannes- entities controlled West African banking industries, burg, and London, thereby gaining access to global Ecobank had by 1990 expanded to five countries in and regional fi nancial markets—a common move by West Africa from its home country of Togo; and by internationalizing developing country banks. 2001 it had further extended its reach to 12 countries Ecobank is particularly notable for the relatively across Africa to become a regional bank. Tradition- small size of its domestic operations; 12 percent of ally serving wholesale customers, by around 2005 its total revenue of $2.1 billion in 2015 originated in Ecobank had gradually transformed itself into a full- Togo. Furthermore, its share of Togolese assets fell service, pan-African bank. A decade later, Ecobank from 16.5 percent in 2011 to 9.2 percent in 2015, sug- is among the few multinational fi nancial institutions gesting significant expansion into the wider African operating extensively beyond their home countries in economy. Africa (Beck, Fuchs, and others 2014). With 1,239 However, Ecobank’s achievements as a sizable banking offices in 33 countries across the continent regional bank in Africa have not been without chal- (see figure B2.3.1), Ecobank has a footprint in Africa lenges. In 2013, the bank went through turmoil that surpasses that of any bank in the world.a related to corporate governance issues, which also Since 2011, Ecobank has been rebalancing its produced judiciary and political tensions among presence in neighboring Nigeria (Nigeria is the home home and host countries. Given the complexity of of Ecobank’s largest subsidiary, holding 40 percent international banks, this experience has highlighted of the group’s assets) in order to further grow into the importance of strong legal institutions in empow- central, eastern, and southern Africa. The redistri- ering supervision and regulatory enforcement. Fur- bution of its activities to different regions is aimed thermore, it shows that the increasing geographical at obtaining more profitability and efficiency as reach of international banks also warrants deepening well as reevaluating its business model. The group cross-border information sharing and coordination also has established representative offi ces in fi nan- mechanisms for banking supervision. a. Ecobank relies extensively on a network of subsidiaries, as opposed to parent-reliant branches. 50 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Recent studies have found that the location in high-income countries find that domestic decisions of foreign banks are influenced not banks are more efficient than foreign banks only by the bilateral distance between their (Berger and others 2000; Chang, Hasan, and home country and the host economy, but also Hunter 1998; DeYoung and Nolle 1996; by how close other competing foreign banks Hasan and Hunter 1996; Miller and Parkhe are to the host economy. The farther away its 2002; Peek, Rosengren, and Kasirye 1999), competitors, the more likely it is that a foreign studies focusing on developing countries find bank will enter a host economy. Claessens and the opposite pattern: foreign banks tend to be van Horen (2014a) introduce this concept as more efficient than domestic banks in terms of “competitor remoteness”—defined as the cost and profits.7 Indeed, consistent with the weighted average distance of all competing evidence from country case studies, empirical banks from a host country—to account for work that exploits large panels of countries the fact that the closest country for a foreign finds that, although in developed countries bank might not be the most attractive one if foreign banks tend to be less efficient than do- the bank’s competitors are already closer to mestic ones, in developing countries the pat- this country. Using bilateral data on 1,199 tern is reversed (Claessens, Demirgüç-Kunt, foreign banks from 75 home countries pres- and Huizinga 2001; Demirgüç-Kunt and ent in 110 host countries, the authors find Huizinga 1999). that closer distance and greater competitor re- The performance of foreign banks in a host moteness increase the likelihood that a foreign country depends on various factors, such as bank will enter a host country. The impact is home country characteristics, geographic and stronger for home and host countries that are cultural determinants, and market structure. not members of the OECD, for banks from In developing countries, foreign banks have countries that have engaged relatively more in lower overhead costs, higher interest margins, FDI, and for host countries in which foreign and higher profitability, which may suggest banks dominate. The richness of their data that foreign banks, in general, bring better allows Claessens and van Horen (2015) to technologies to less developed banking sec- further examine some patterns related to the tors (Claessens, Demirgüç-Kunt and Huizinga recent growth of South–South banking and 2001; Demirgüç-Kunt and Huizinga 1999; the dynamics of foreign bank retrenchment Micco, Panizza, and Yañez 2007). But foreign after the global financial crisis (see box 2.4). banks may not have that technological edge in more developed banking markets. More re- cently, Claessens and van Horen (2012) find IMPACTS OF FOREIGN BANK that foreign banks are relatively more profit- PARTICIPATION able when coming from a high-income coun- try, when the competition in the local banking Competition and Efficiency sector is limited, and when the foreign bank is Evidence suggests that although foreign banks larger. Foreign banks become more profitable are less efficient than domestic banks in high- over time, especially when the host economy income countries, they perform better than shares similar geographical and cultural back- their domestic counterparts in developing grounds with a bank’s home country. countries. Foreign banks may bring superior In principle, the higher efficiency of for- technologies and processes to a host economy, eign banks in developing countries can im- but they face the extra cost of doing business prove the performance of local banks and the abroad. Part of this cost may arise from oper- degree of competition in the system. Foreign ating in a different environment in which for- banks can improve the performance of domes- eign banks may have to familiarize themselves tic banks in several ways. For one thing, the with the institutional development, regulatory increased competition from new foreign play- frameworks, financial markets, or credit risk ers puts pressure on local banks to increase of the host economy. Whereas most studies their efficiency by, for example, reducing their GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 51 BOX 2.4 Dynamics of Postcrisis International Bank Retrenchment: From Globalization to Regionalization? Several major international banks headquartered Nevertheless, the dynamics of entry and exit in high-income member countries of the Organisa- among foreign banks reveal some interesting trends tion for Economic Co-operation and Development, (see figure B2.4.2). Greenfield entries have been simi- such as Deutsche Bank, recently announced plans to lar for high-income and developing country foreign drastically reduce the number of countries in which banks (panel c), but closures have been mainly by they operate. The general view has been that fi nan- the foreign banks of high-income countries (panel d). cial markets have been fragmenting since the global In terms of foreign acquisitions of domestic banks, fi nancial crisis. However, as Claessens (2016) argues, in the precrisis period most domestic banks were fragmentation of the financial systems has been acquired by banks from high-income countries. After observed more in cross-border claims than in foreign the crisis, the number of foreign acquisitions dropped bank presence. drastically (panel a), and of those acquisitions that A comparison over time of the number and size did take place, most were by foreign banks from of subsidiaries of foreign banks reveals that retrench- developing countries. In some regions, the retrench- ment has not been that severe. Even though the num- ment of global banks has been accompanied by an ber of foreign banks headquartered in high-income expansion of regional players. As panel b shows, countries declined after the crisis (Claessens and van most ownership transferals of foreign banks have Horen 2015), in terms of their assets, foreign banks been from high-income foreign banks to banks from from high-income countries that continued to oper- developing countries. All in all, even though the ate abroad grew, widening the gap (in terms of assets) overall number of foreign banks has remained stable, between them and foreign banks from developing significant changes in the composition of banks have countries (see figure B2.4.1). been observed in recent years. FIGURE B2.4.1 Growth over Time of Foreign Banks by Number of Subsidiaries (2000–13) and Average Assets (2005–13) a. Number of subsidiaries b. Average assets 700 7 600 6 Average assets (US$, trillions) 500 5 No. of subsidiaries 400 4 300 3 200 2 100 1 0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 05 06 07 08 09 10 11 12 13 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 High income Developing Source: Analysis based on Claessens and van Horen’s Foreign Bank Ownership Database, matched with consolidated Bankscope statements (Claessens and van Horen 2015). Note: “High income” and “developing” categories correspond to banks headquartered in high-income and developing countries, as defined by the World Bank. The gray area indicates the global financial crisis period. (box continued next page) 52 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 2.4 Dynamics of Postcrisis International Bank Retrenchment: From Globalization to Regionalization? (continued) FIGURE B2.4.2 Acquisitions, Transferals, Greenfield Entries, and Closures of Foreign Banks, 2000–13 a. Foreign acquisitions of domestic banks b. Ownership transferals of foreign banks 40 16 30 12 No. of acquisitions No. of transferals 20 8 10 4 0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 00 01 02 03 04 05 06 07 08 09 10 11 12 13 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 High-income Developing High-income to developing Developing to high-income c. Foreign greenfield entries d. Foreign bank closures 30 25 25 20 20 No. of entries No. of closures 15 15 10 10 5 5 0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 00 01 02 03 04 05 06 07 08 09 10 11 12 13 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 High-income Developing High-income Developing Source: Analysis is based on Claessens and van Horen’s Foreign Bank Ownership Database, matched with consolidated Bankscope statements (Claessens and van Horen 2015). Note: “High-income” and “developing” categories correspond to banks headquartered in high-income and developing countries, as defined by the World Bank. The gray area indicates the global financial crisis period. costs and offering products of higher qual- 2008). For another, through spillovers local ity. In particular, the greenfield entry of for- banks can learn from foreign banks about new eign banks increases the number of banks in financial services, better practices, or more so- the host economy, induces more competition, phisticated techniques (such as risk manage- and could lead to lower market concentration ment, personnel training, or data processing) (Claeys and Hainz 2014; Lehner and Schnitzer that make them more efficient, even without GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 53 directly competing with their foreign peers particularly when more efficient and less risky (Lehner and Schnitzer 2008; Zhu 2012). foreign banks enter markets with less concen- The empirical evidence mostly indicates trated banking sectors. that foreign bank participation is positively Recent empirical studies have attempted to related to bank competition and efficiency in quantify the role of knowledge spillovers from host countries. Analyzing a panel of 80 coun- foreign to domestic banks. Besides the direct tries over time, Claessens, Demirgüç-Kunt, impact of foreign banks on competition, a and Huizinga (2001) find that in developing host economy might experience further gains countries, a larger foreign ownership share as it opens up to foreign bank entry (Goldberg of banks is associated with the lower profit- 2009). These gains can take the form of tech- ability and margins of local banks. The effects nology transfers, institutional change, pro- of foreign bank entry are apparent shortly ductivity enhancements, and wage spillovers upon entry, and they do not increase as for- from foreign banks. Such spillover effects eign banks gain market share. More recent are documented by Zhu (2012), who finds cross-country studies confirm a positive link that the managerial performance of domestic between foreign bank entry and competition. banks in Eastern Europe and Latin America Using bank-level data over time across 17 is positively linked to foreign bank presence. developing countries, Jeon, Olivero, and Wu The gap in managerial efficiency between for- (2011) demonstrate that when foreign bank eign and local banks not only narrows over penetration increases, competition in the time but also does so even when competition banking sector of the host economy improves, is low. Box 2.5 presents a case study of such BOX 2.5 Improving Rural Finance in Albania through Knowledge Exchange In Albania, as in many developing countries, the ing countries. They targeted smallholders, small financing needs of households and firms in rural and medium-sized enterprises, and individuals who areas are largely met by cooperative fi nancial insti- lacked access to banking services. Their strategy tutions (CFIs). Although CFIs have an extensive consisted of merging several small savings and credit information network in local areas, their governance associations (SCAs) into a one-tier operational struc- and technological and institutional capacity tend to ture, with a multitier governance model that would be weak, and their regulation is usually not well provide the new institution with greater economies defi ned. of scale in terms of products and services and would In 2014 the Albanian Savings and Credit Union improve its access to fi nancial markets, yet with con- (ASCU) approached the European Fund for South- tinued bottom-up member involvement. east Europe (EFSE) and Rabobank, an international As part of the reform, the cooperative legal and bank with vast experience in providing financial judicial framework was amended to provide room for services to small and unbanked clients, for help in the sector to grow and consolidate under a stronger designing and implementing a structural reform regulatory regime. A more inclusive deposit insur- that would allow it to professionalize and organize ance agency was also designed in order to include its operations on a par with commercial banks. The financial cooperatives. As a result, by the end of ASCU, a CFI that was established in 1992, provides 2015, 70 out of the 84 rural SCAs were merged into microloans to over 30,000 rural families in Albania one large SCA, even before the new cooperative law (Rabobank 2015). It has built a strong local presence was ratifi ed. It was a unique achievement because and a healthy asset portfolio, but further growth has very few CFIs have leapt forward to welcome a one- been hampered by a weak institutional capacity, a tier operational structure. In February 2016, the new lack of information technology, and limited funding. financial institution, called FED, was licensed by the The reform was a collaborative effort among Bank of Albania. The EFSE and Rabobank will con- regulators, ASCU, and Rabobank, a large Dutch tinue to support FED for three years by providing cooperative bank with subsidiaries in 23 develop- technical assistance for the restructuring process. 54 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 knowledge transfers from the experience of a the other, shocks from abroad may be more large Dutch bank operating in Albania. easily imported. Studies of financial stability Evidence suggests that the role that foreign find that the degree of risk sharing is mixed banks play in a host economy is also deter- because it depends on conditions in both the mined by the mode of entry. When foreign host and home countries. The impact of for- banks expand abroad, one decision they face eign banks on the stability of host economies is the mode of entry—that is, through green- has been studied widely. Foreign banks have field investments or acquisition of existing been found to adjust their lending when finan- banks. Some theories suggest that this deci- cial or macroeconomic factors in the home or sion is largely influenced by the efficiency of host country change, which may have am- the entering bank in screening potential cli- biguous effects on the stability of the host ents. If the bank is inefficient (for example, if economy. Foreign banks may enhance the sta- information about clients in the local market bility of a domestic banking system exposed is nonexistent or too costly), then the bank to local shocks because they have access to may choose to enter through acquisitions liquidity and capital from their parent com- and make use of the information already pos- panies. In addition, because foreign banks are sessed by the acquired bank. With increasing typically more diversified than domestic ones, efficiency, greenfield entry becomes more at- they should be less affected by local shocks. tractive for a foreign bank (Lehner 2009). And yet foreign banks could also destabilize The type of entry will affect not only the host economies by transmitting shocks from number of competitors in the host economy their home country or other countries where but also the way in which information is dis- they operate.8 Destabilization of the domes- tributed among foreign and domestic banks, tic banking sector may also occur through which in turn will influence the degree of competitive pressure if, for instance, foreign competition in the domestic banking sector banks push local banks to riskier segments or (Claeys and Hainz 2006). Empirical work even to exit the market. Alternatively, as box has found that foreign bank entry via green- 2.6 discusses, foreign banks may hinder the field investments has a stronger positive effect stability of the domestic banking sector by in- on competition than entry via M&As—see creasing the foreign exchange risk of the host Claeys and Hainz (2014) and Jeon, Olivero, economy. and Wu (2011). Exploiting a large sample Countries with a higher foreign bank pres- of countries over time, Delis, Kokas, and ence appear to have fewer crises. Analysis of Ongena (2014) confirm these results, but they bank-level data across 80 developed and de- also find that as the share of foreign banks in veloping countries suggests that greater for- a host economy increases, the market power eign bank participation is associated with a of the average bank in the industry also rises. reduced probability of financial crises in the This occurs because the primary mode of en- host country (Demirgüç-Kunt, Levine, and try of foreign banks is through M&As. And Min 1998). Barth, Caprio, and Levine (2004) yet, even though foreign banks are more ef- compare the performance and stability of the ficient, that efficiency does not translate into banking sectors in a sample of over 100 coun- more competitive pricing. Meanwhile, even tries with those countries’ regulatory and su- though greenfield investments are associated pervisory practices. They find that countries with higher levels of competition, they are not that impose official barriers to foreign bank necessarily associated with greater access to entry tend to have more fragile banking sec- financial services. tors and, in particular, tend to have a higher likelihood of a major banking crisis. Meanwhile, credit growth from foreign Financial Stability banks can be more resilient during local fi- International banks play a risk-sharing role in nancial turmoil. Using bank-level data for the host economy in which, on the one hand, over 300 foreign and domestic banks oper- local shocks may be better diversified, but, on ating in 10 Eastern European countries, De GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 55 BOX 2.6 Foreign Exchange Risk: The Case of Latvia In the absence of a well-developed local currency its pegged exchange rate. They argue that the fi xed deposit base, most of the funding for international exchange regime was widely believed to be perma- banks may be in a foreign currency, either from their nent, encouraging borrowers and lenders to issue parent entities, international capital markets, or and obtain debt in euros, assuming no exchange international fi nancial institutions. Foreign exchange rate risk. However, once the global recession hit risks pose a problem when banks lend in a foreign and foreign banks began retrenching, exchange rate currency to households and fi rms with incomes and uncertainty substantially impacted the economy. The assets denominated in the local currency. While bor- Latvian authorities decided to maintain the fixed rowers may fi nd debt contracts in a foreign currency exchange rate, and thus allow the adjustment in the attractive due to lower interest rates, they are unable real exchange rate to take place via declining prices to protect themselves against future exchange rate and wages. Even though the nominal exchange rate fluctuations. Concerns are even greater when longer- was left untouched, increasing numbers of borrow- term loans, such as mortgages, are extended in a for- ers were not able to pay off their loans due to fall- eign currency. ing incomes and unemployment.a In the third quarter During the global fi nancial crisis, Latvia show- of 2010, NPLs in Latvia were 19.4 percent of total cased the negative consequences that foreign cur- loans (Škarica 2014). rency lending can bring (IEG 2012). In 2008, Latvian Foreign exchange risk is not exclusively attached subsidiaries of Nordic banks accounted for 60 per- to foreign currency loans. Collecting deposits in a cent of total banking sector assets. Their increased foreign currency may also distort local credit mar- presence also brought a rise in the proportion of kets, as funding in the local currency may drop. This loans denominated in a foreign currency, which rose was the case in Azerbaijan, where foreign banks from 50 percent in 2001 to more than 85 percent in received a high share of their deposits in a foreign 2007 (Blanchard and others 2013). By 2007, the IMF currency. When the government banned foreign warned that rapid growth in credit in foreign curren- currency loans to unhedged borrowers, banks had cies was leading to large currency mismatches on the to curb total lending because their local currency balance sheets of fi rms and households and a boom funds were insufficient to support it. Moreover, once in housing prices (Cordero 2009). devaluation hit, foreign currency deposits became According to Weisbrot and Ray (2010), one extremely costly for foreign banks. important driver of the fi nancial crisis in Latvia was a. Beck, Jakubik, and Piloiu (2013) note that even though the foreign exchange rate was kept fi xed during the crisis, since interest rates had to increase to defend the fi xed exchange rate, higher lending rates were one of the factors that contributed to the large increase in NPLs among households and fi rms. Haas and van Lelyveld (2006) study the re- and van Lelyveld (2010) analyze data from sponses of banks to changing business cycle multinational banking groups to examine conditions and to domestic financial crises. the extent to which parent banks manage the Their findings show that during financial credit growth of their subsidiaries abroad. crises, domestic banks contract their credit Consistent with previous findings, their evi- and deposits, whereas foreign banks continue dence confirms that when a host economy is lending at the same level. Similar findings are hit by a banking crisis, parent banks can inject drawn from a study analyzing banks across funds in their subsidiaries in order to main- 20 Asian and Latin American countries from tain their levels of credit supply.9 In line with 1989 to 2001 (Arena, Reinhart, and Vazquez this research, Cetorelli and Goldberg (2012b) 2007). The study documents that, compared show that internal capital markets are active with those of local banks, the lending and de- in international banks and that parent sup- posit rates of foreign banks have a smoother port makes foreign bank subsidiaries more re- pattern in times of financial distress. De Haas silient than local banks. Finally, a recent study 56 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 by Demirgüç-Kunt and others (2017) reveals throughout the crisis period. The more diver- how a greater foreign bank presence in an in- sified foreign banks continued lending and ternational sample of countries makes cross- had substantially higher profits and fewer border lending (through syndicated loans) nonperforming loans than both local banks more stable and less destabilizing in response and foreign banks specializing in the region. to international monetary policy shocks.10 Evidence suggests that the stabilizing role of The study also illustrates the interaction be- foreign banks is greatly dependent on the char- tween brick-and-mortar activities—the focus acteristics of their parent banks. Analyzing the of this chapter—and cross-border lending, lending patterns of a large sample of domestic which is examined in chapter 3. and foreign banks, a report by the IMF finds The stabilizing role of foreign banks dur- that the lending behavior of foreign subsidiar- ing local financial crises is further confirmed ies during financial crises varies (IMF 2015c). in several studies at the country level. Only Foreign subsidiaries of better-capitalized par- a few studies at the country level have exam- ent banks and parent banks with more stable ined the role of foreign bank participation funding sources tend to be more stable lend- during periods of financial crisis. Overall, the ers. This heterogeneity across foreign banks findings from these studies support the previ- may help explain why some studies see more ously discussed cross-country results; foreign nuanced results when analyzing the lending banks appear to have a stabilizing effect in procyclicality of foreign banks. In some stud- times of financial distress. Goldberg, Dages, ies, the lending from foreign banks is shown and Kinney (2000) analyze the experiences of to be more procyclical than that of domestic Argentina and Mexico in the 1990s by exam- banks. If lending from foreign banks accen- ining bank-level quarterly loan data for each tuates the business cycles of host economies, country. Their findings reveal that in both then financial instability can increase. In good countries, foreign banks were more stable times, lending from foreign banks may fuel lenders than local banks. The authors argue lending booms, possibly associated with the that having diverse ownership in the banking lower lending standards of banks (Dell’Ariccia system is important because it, in turn, di- and Marquez (2006b); and in bad times, it versifies the sources of foreign funding in the may worsen the credit crunch.11 Albertazzi banking system. Crystal, Dages, and Gold- and Bottero (2014) find the latter for Italy af- berg (2001, 2002) also analyze Latin Ameri- ter the collapse of Lehman Brothers. Notably, can foreign and local banks in the late 1990s, their results are driven by foreign banks with a which was a period characterized by both the lower local presence, proxied by loans over lo- large entry of foreign banks in the region and cal deposit funding. Box 2.7 describes further significant macroeconomic stress. They find empirical evidence of a higher lending cyclical- that throughout this period, foreign banks ity for foreign banks. had consistently stronger credit growth, were As South–South banking and bank region- more aggressive in addressing asset quality alization expand, the stabilizing role of foreign deterioration, and were better able to absorb banks may change. On the one hand, closer losses. More nuanced evidence from Malaysia geographical proximity to the host country highlights the importance of diversification could limit the potential of foreign banks among foreign banks. Detragiache and Gupta to diversify shocks because shocks are more (2006) compare the performance of local and likely to be correlated between host and home foreign banks in Malaysia during the Asian countries. On the other hand, greater prox- crisis of the late 1990s, distinguishing foreign imity (physical, institutional, or cultural) may banks that specialize in Asia from those that facilitate communication and coordination have more diversified operations outside Asia. between host and home country authorities. The study finds that diversified foreign banks Moreover, differences in the funding sources were crucial in helping the banking system of the new generation of foreign banks (such GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 57 BOX 2.7 The Lending Cyclicality of Foreign Banks Bertay, Demirgüç-Kunt, and Huizinga (2015) com- FIGURE B2.7.1 Change in Bank Lending Associated pare cyclicality in lending across different types of with a 1 Percent Increase in GDP per Capita, 1999–2010 banks (private versus state-owned, and domestic ver- 2.5 sus foreign-owned) for a yearly panel spanning 1999 to 2010 and consisting of 1,633 banks from 111 2.1*** 2.0*** 2.0*** countries. 2.0 In their sample, 52.8 percent of bank-year obser- vations correspond to private domestic banks, fol- 1.5 Percent lowed by 35.8 percent to private foreign banks and 1.3*** 11.4 percent to state-owned banks. To examine cycli- cality in lending, they analyze how the credit growth 1.0 0.9** of the different types of banks in a given period is 0.6 associated with the growth rate of the gross domestic 0.5 product (GDP) per capita (as a measure of the busi- ness cycle). 0 Their results confi rm that, although lending from Full sample High-income Developing state banks is essentially insensitive to GDP per cap- countries countries ita growth, lending from private banks increases as Foreign banks Domestic banks GDP rises, and it increases even more strongly for foreign banks. Specifi cally, a 1 percent increase in Source: Recalculated from Bertay, Demirgüç-Kunt, and Huizinga 2015. Note: The figure shows the marginal effects of a regression of bank lending on GDP per capita growth leads to credit growth of GDP per capita growth and other control variables, estimated using a sample 1.0–1.1 percent for private domestic banks and 2.1 of 1,633 banks from 111 countries. Developed economies are defined as high- income countries based on the World Bank classification, and the rest of the percent for private foreign banks. countries are defined as developing economies. ** and *** indicate statistical Overall, the authors find evidence that the lending significance at the 5 and 1 percent levels. of foreign banks is more sensitive to macro develop- ments in the host country (and thus more procyclical) than that of their domestic counterparts (see figure B2.7.1), which may have consequences for fi nancial lar lending behavior during the crisis among domes- stability. One explanation may be that, with funding tic banks and the six multinational European banks from their international parents, foreign banks are (the “Big Six”) that were operating in Bulgaria, Croa- more likely to take advantage of local lending oppor- tia, the Czech Republic, Hungary, Poland, Romania, tunities during economic booms. The authors are the Slovak Republic, and Slovenia. By contrast, the not able to identify the parents of the foreign banks lending of other foreign banks operating in these they study, and thus are unable to test this conjecture countries was much more procyclical than that of directly. domestic banks. These authors speculate that the Big However, evidence from other sources indicates Six treated these countries as something akin to a the substantial heterogeneity in the cyclicality of second home market. lending among foreign banks. For example, Cull As noted, during many of the crisis episodes in and Martínez Pería (2013) fi nd that foreign banks in the banking sectors of developing countries, foreign Eastern Europe were better able to maintain credit banks were better able to maintain lending than growth during the global financial crisis if their par- domestic banks. A report by the IMF (2015a) provides ents were profitable and liquid (although the same bank-level evidence across countries that foreign- patterns did not hold in Latin America, where the owned subsidiaries, and in particular those with solvency of the subsidiaries themselves proved more well-capitalized parent banks, lend less procyclically important). Bonin and Louie (forthcoming) fi nd simi- than domestic banks during domestic crises. 58 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 as local deposits versus equity, and short-term of credit in the United States that was in- funding versus long-term funding) may also dependent of the demand for credit in the influence the stability of their credit behavior. United States. The authors found that Japa- As figure 2.1 shows, South–South subsidiar- nese banks operating in the United States sig- ies are increasingly being funded by local de- nificantly reduced their supply of credit as a posits, which during the global financial crisis result of the collapse of stock prices. Using proved to be a more stable source of funding, a similar event, Chava and Purnanandam enabling foreign banks to better smooth their (2011) and Schnabl (2012) examine how the lending throughout the crisis. During that pe- 1998 Russian crisis was transmitted via for- riod, local deposits accounted for 57 percent eign banks to borrowers in the United States of funding for South–South subsidiaries and and Peru, respectively. 47 percent for North–South subsidiaries. There is growing evidence for the trans- Although foreign banks can attenuate lo- mission of foreign monetary policies to host cal shocks in a host country, they also can economies via foreign banks. In recent years, spread shocks from one country to another. policy makers and scholars have been con- The literature also suggests that, as with any cerned that the foreign monetary policy of other risk-sharing scheme, foreign banks can developed countries may have substantial pass external shocks to the host economy. spillovers into the credit cycles and financial Among the first studies to employ a rigorous stability of developing countries (Fischer and methodology to causally identify that shocks others 2014; Rajan 2014; Rey 2015). A recent can be transmitted across countries via for- study of Mexico by Morais and others (forth- eign banks was that by Peek and Rosengren coming) uncovered rigorous evidence that (1997, 2000). This study exploited the col- foreign banks transmit the monetary policy lapse in Japanese stock prices in the late of their home countries through the lending 1980s as an exogenous shock to the supply of their subsidiaries in host economies. The FIGURE 2.1 Contribution of Local Deposits, Equity, and Short-Term and Long-Term Funding to Total Bank Funding, 2000–14 a. Customer deposits by North–South subsidiaries b. Customer deposits by South–South subsidiaries 100 100 90 90 80 80 70 70 60 60 Percent Percent 50 50 40 40 30 30 20 20 10 10 0 0 2000 2002 2004 2006 2008 2010 2012 2014 2000 2002 2004 2006 2008 2010 2012 2014 Customer deposits Equity Money market and short-term funding Long-term funding Other Source: Bertay, Demirgüç-Kunt, and Huizinga 2017. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 59 authors found that the credit supply of foreign Since the global financial crisis, a large banks increases when the monetary policy of number of studies have examined in greater their home country softens. The future de- depth the ways in which foreign banks con- faults on these loans also increase, suggesting tribute to cross-border contagion. The vast that foreign banks may be engaging in more majority of studies use microdata to disen- risk taking abroad when their home country tangle the effects of supply and demand. policy rates are low. Box 2.8 presents a more The evidence is consistent with the fact that detailed discussion of this study, and chapter during the crisis, foreign banks contracted 3 discusses the international transmission of their lending earlier and faster than domestic foreign monetary policies at greater length. banks. Aiyar (2012) finds that in the United BOX 2.8 The Transmission of International Monetary Policy via Foreign Banks in Mexico Morais and others (forthcoming) analyze the impact tions change. In other words, fi rms could neutralize that foreign monetary policy, transmitted via banks’ international shocks by replacing bank credit from lending channels, has on Mexican firms. Over a foreign banks with other sources of fi nance. If fi rms 10-year period, using the universe of new and out- fi nd it costly to change banks and thus cannot pro- standing commercial bank loans, they examine tect themselves from the shocks transmitted by their monetary policy shocks in the form of interest rates banks, foreign monetary policy shocks could have real and nonstandard quantitative easing (QE) transmit- effects on the performance and operations of fi rms. ted from three regions: the United States, the United The study results indicate that a softening of for- Kingdom, and the euro area. The main foreign banks eign monetary policy increases the supply of credit operating in Mexico have their headquarters in these that foreign banks extend to Mexican fi rms. Con- regions. sistent with the evidence on the transmission of One of the main challenges in identifying the monetary policy from home to host countries, each impact that foreign monetary policy has on the sup- type of regional policy shock affects supply via each ply of credit is that both the supply and demand for region’s foreign banks. For example, U.S., U.K., and credit may change in response to a monetary policy euro area monetary policies affect the credit supply shock. Morais and colleagues overcome this chal- to Mexican fi rms via those regions’ banks in Mexico. lenge in two ways. First, they compare loans offered All loan terms are affected (loan volume, maturity, in the same period to the same fi rm by different for- loan interest rate, and collateral rate), but the effects eign banks exposed to different monetary policies, are substantially weaker for loan rates. Moreover, thereby allowing them to hold the demand for credit the international monetary policy channel implies constant. Second, because only 21 percent of all firms strong real effects, with substantially stronger elas- borrow from multiple banks in the same period, they ticities from monetary rates than from QE. also compare loans offered by different foreign banks A decline in foreign monetary policy rates and an in the same period with fi rms from the same state expansion of QE lead to a higher credit supply for and industry—an alternative way to hold the demand borrowers with higher ex ante loan rates (consistent for credit constant. with a reach-for-yield) and substantially higher ex To identify whether the transmission of foreign post loan defaults, which suggests that foreign banks monetary policy through bank credit leads to real increase their risk taking when their country’s mone- effects on firms, they examine the dynamics of firms’ tary policy softens. Furthermore, foreign QE is found assets, employment, and total credit from any source. to bring about greater risk taking in emerging mar- Analyzing these variables is important because fi rms kets through an expansion of credit to riskier fi rms may switch from foreign bank credit to credit from rather than improving the real outcomes of firms in other banks or other sources when their credit condi- those markets. 60 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Kingdom, the shock to external bank fund- market and show that greater exposure to ing caused by the crisis led to a substantial re- banks in crisis-affected countries reduces prof- duction in banks’ credit supply, driven mainly itability and the supply of new credit (Hale, by branches of foreign banks. In the Russian Kapan, and Minoiu 2016). Federation, foreign banks reduced their lend- There are, however, ways to reduce the ing more than other banks (Fungáčová, Her- international transmission of shocks from rala, and Weill 2013).12 One conclusion from home to host countries. By analyzing the Vi- a review of the literature is that the responses enna Initiative, in which some parent banks of foreign banks to shocks vary substantially, committed to supporting their subsidiar- depending on country and bank-level charac- ies in emerging Europe, De Haas and others teristics. The evidence suggests that the trans- (2015) show that cross-border coordination mission of shocks is stronger when regulation efforts can reduce cross-border transmission is lax in the home country (Bertay 2014) or and make foreign subsidiaries relatively stable in host countries (Anginer, Cerutti, and Mar- lenders without imposing negative externali- tínez Pería 2017). The transmission of shocks ties on the other countries in the region. Since also appears to be stronger among host coun- the global financial crisis, other initiatives, tries that are more financially open and that such as alternative cross-border resolution have more competitive banking sectors (Jeon, schemes, have been put in place with the ob- Olivero, and Wu 2013). As for bank-level jective of reducing the cost of future financial characteristics, the transmission of shocks is crises. A comprehensive review of the differ- stronger for foreign banks that have lower ent approaches that have been followed for levels of capital, are less profitable, and are the regulation, supervision, and resolution of more dependent on their parent banks (Ang- global banks is presented later in this chapter. iner, Cerutti, and Martínez Pería 2017; Choi, Foreign banks may also transmit shocks Gutierrez, and Martínez Pería 2014; De Haas from their host countries to their home coun- and van Lelyveld 2014; De Haas and others tries, hindering the home countries’ stability 2015; Jeon, Olivero, and Wu 2013; Popov (Cetorelli and Goldberg 2012b). Buch and and Udell 2012). In addition, the transmission others (2012) look at the impact of the in- of shocks is stronger if foreign banks entered ternationalization of German banks on the host markets via greenfield investment rather structure and risk taking of Germany’s bank- than M&As (Jeon, Olivero, and Wu 2013). ing sector. They find that bank international- Recent studies have furthered understand- ization is weakly related to bank risk. Some ing of how foreign banks can lead to cross- recent studies, however, imply that bank in- border contagion. Cetorelli and Goldberg ternationalization leads to higher bank risk (2012a, 2012b, 2012c) and Jeon, Olivero, and for the (internationalizing) parent bank—see Wu (2013) reveal the existence of an active Berger and others (2016) focusing on U.S. cross-border internal capital market whereby banks and Gulamhussen, Pinheiro, and Poz- global banks reallocate funds across their zolo (2014) for an international sample of branches and subsidiaries to buffer shocks banks. Nevertheless, evidence from the recent to the parent bank’s balance sheet. These financial crisis suggests that the parent banks, studies show how a monetary policy shock especially those with liquid foreign subsidiar- in the home country can spill over to other ies, were better able than their domestic coun- countries through a reduction in lending by terparts to protect their home country opera- global banks’ subsidiaries. Global banks also tions (De Haas and van Lelyveld 2014). contribute to the transmission of shocks via Foreign banks may also experience sys- interbank lending. The authors of a recent temic risk consequences because of their study construct a network of direct and indi- size and complexity. The associations be- rect bilateral exposures using detailed data on tween bank size and bank performance and loan transactions in the syndicated interbank activity mix and funding strategy have been GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 61 documented for an international sample of Access to Credit banks by Bertay, Demirgüç-Kunt, and Huiz- inga (2013), who differentiate between ab- The impact that foreign bank participation solute and relative (to national economies) can have on overall access to credit is greatly size. They find that bank returns increase dependent on host country factors. On the with absolute bank size but decrease with one hand, the advantages that foreign banks systemic size (proxied by bank size with re- could bring to a host economy, such as supe- spect to national GDP), and that returns are rior technology, better supervision practices, uncorrelated with bank risk measured by the or achievement of larger economies of scale, Z-score. Focusing on bank holding compa- may allow these banks to overcome the costs nies in the United States, Hughes and Mester of doing business abroad, and they may ma- (2013) provide evidence of economies of scale terialize in more widespread access to credit. for both small and large banks, and they ar- In principle, these advantages could give gue that those economies are not driven by foreign banks an edge with segments of the too-big-to-fail subsidies. Nevertheless, banks, population that are underserved by domestic especially in advanced economies, suffered banks. On the other hand, the cost of acquir- very large losses during the crisis, and regula- ing information about new clients may be too tors have taken steps to end the too-big-to-fail high for foreign banks, forcing them to lend problem. Indeed, recent regulatory changes exclusively to the largest, safest firms. Access may have important implications for bank to credit may be hindered if foreign banks not internationalization because larger banks are only limit their lending to the largest custom- increasingly tending to become international. ers but also, by their entry, force domestic Large, internationally active banks that face banks out of the market. Aggregate credit in regulatory scrutiny of their risk capital alloca- the host country may then contract, particu- tion in both home and host countries may de- larly among the smaller and more informa- cide to reduce their international operations tionally opaque clients that previously were (as discussed in box 3.5 in chapter 3 or, as dependent on credit from domestic banks. observed anecdotally, from Deutsche Bank’s Detragiache, Tressel, and Gulpta (2008) and exit from many markets). Gormley (2014) develop theoretical frame- One other crucial dimension of large works to illustrate that only under certain banks is their complexity. Cetorelli and conditions does the entry of foreign banks Goldberg (2014) propose measures to cap- increase access to credit. One implication of ture two aspects of the complexity of global these models is that foreign banks are more banks: “organization” complexity, account- likely to have a negative effect on credit access ing for the number and geographic spread in host economies where obtaining informa- of an institution’s affiliates; and “business” tion is costly (Gormley 2014). complexity, capturing the type and variety of Consistent with theory, empirical research activities of an institution. These measures reveals a negative association between for- reveal a substantial degree of diversity in eign bank entry and access to credit in host complexity within the universe of U.S. banks countries with less competitive banking sec- and prompt a call for further research on the tors or weak institutional and legal environ- positive and negative externalities generated ments.13 Behn and others (2014) analyze a by complexity. In a recent study, Carmassi sample of 26 developing countries around the and Herring (2015) analyze the corporate time of bank liberalization and find that in complexity of global systematically impor- countries with more competitive local banks, tant banks (G-SIBs), finding a significant foreign bank entry resulted in a greater sup- increase in complexity (proxied by the num- ply of credit. By contrast, host countries with ber of majority-owned subsidiaries) through less competitive banking sectors experienced 2011. a reduction in aggregate lending, whereby 62 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 foreign lending mostly crowded out lending lead to an overall increase in credit supply from domestic banks. Similarly, exploiting in the host economy. Several studies provide India’s commitment to the World Trade Or- evidence in favor of this mechanism. Clarke, ganization (WTO) to allow a greater foreign Cull, and Martínez Pería (2006), analyzing a bank presence during the 1990s, Gormley sample of firms from developing and transi- (2010) presents further evidence of a negative tion countries, reveal that foreign bank par- effect of foreign banks on access to credit in ticipation is associated with better financing the country.14 In a sample of 137 countries conditions for all firms, even though the firms over 1995–2009, Claessens and van Horen that benefit most are the largest ones. Similar (2014b) find a negative correlation between evidence from Eastern Europe also indicates the presence of foreign banks and the ratio of that, even though foreign banks target larger private credit to GDP in low-income coun- firms, access to credit for small and medium- tries, in countries where contract enforcement sized enterprises (SMEs) is not reduced by the is costlier and access to credit information is presence of foreign banks (De Haas, Ferreira, limited, in countries where the share of for- and Taci 2010; Giannettia and Ongena 2012). eign banks is smaller, and in countries where Alternatively, foreign banks may adopt parent banks are located far away.15 These new lending technologies to expand their findings are consistent with the theoretical business to SMEs. Even though relationship implications that highlight the importance lending is challenging and costly for foreign of the information environment (as modeled banks, these banks have found alternative in Dell’Ariccia and Marquez 2004) and con- technologies that rely on hard information tract enforcement in reaping the benefits of and allow them to lend to more opaque firms increased access to credit from foreign banks. (Berger and Udell 2006). In this way, even In countries with a more competitive bank- when customers do not have formal finan- ing sector, one way in which foreign banks can cial statements, they may have other types expand overall access to credit is by pushing of hard information that allow banks to cal- domestic banks to lend to smaller clients. Even culate their repayment probability. Some of though foreign banks may have more funding the technologies targeted to more informa- sources or better screening technologies than tionally opaque customers are credit scoring, domestic banks, local banks have better infor- asset-based lending, factoring, leasing, and mation about the quality of local borrowers, fixed-asset lending. Public policies aimed at and in particular about the more information- improving the informational, legal, and regu- ally opaque ones, which gives them a com- latory environments in which financial insti- parative advantage in serving these segments tutions operate could make it possible to use (Dell’Ariccia and Marquez 2004). By offering these technologies, and thus, affect access to more competitive services, foreign banks may credit for more informationally opaque cus- attract the best clients in the host economy, tomers. Box 2.9 provides more detail on these pushing domestic banks to improve their ser- alternative lending technologies and foreign vices to prevent good clients from switching banks’ approach to SME lending. banks. Alternatively, domestic banks may Foreign banks can also affect governments’ also be pushed to expand their operations to access to finance. Home bias in sovereign debt SMEs and other previously underserved cli- involving domestic banks is well-documented ents. Several studies from different regions (Hesse, Bakhache, and Asonuma 2015; Hor- have corroborated that foreign banks lend in váth, Huizinga, and Ioannidou 2015). Some- general to the largest and safest borrowers.16 times called the “doom loop,” home bias is Thus for those domestic banks trying to com- a problem because it ties a government’s de- pete with foreign banks for the large, more fault to banks’ defaults (Reuters 2013).17 informationally transparent firms, it may be One possible explanation for this home bias preferable to expand their business to smaller, in sovereign debt is moral suasion by the more opaque customers. This, in turn, may government toward domestic banks. Indeed, GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 63 BOX 2.9 Lending Technologies of Foreign Banks and Their Approach to SME Lending Typically, studies comparing foreign banks with from Clarke and others (2005), who fi nd that large domestic banks point to the screening technologies foreign banks in four Latin American countries used to assess credit risk as one of their main dif- lend as actively to small and medium-sized enter- ferences. Because local banks have better informa- prises (SMEs) as large domestic banks. Similarly, tion on domestic customers, they can rely on soft Beck, Ioannidou, and Schäfer (2012) use detailed information to evaluate these customers’ creditwor- credit registry data on the terms and pricing of thiness. In the absence of soft information, foreign loans to show that foreign banks in Bolivia are able banks need to rely more on the hard information to serve the same clientele as domestic banks by offered by credit bureaus and found in collateral reg- requiring collateral, imposing shorter maturities on istries and audited balance sheets and income state- loans, and basing their pricing on credit ratings and ments (Cull, Martínez Pería, and Verrier 2017). collateral pledges. Indeed, large fi nancial institutions and foreign De la Torre, Martínez Pería, and Schmukler banks have developed and implemented innovative (2010) surveyed 48 banks across 12 countries to business strategies and technologies that, by relying document to what extent banks are engaged in SME on hard information, facilitate arm’s-length lend- lending. Their findings suggest that most banks, ing to more informationally opaque fi rms (Berger including large and foreign ones, are not only inter- and Udell 2006; De la Torre, Martínez Pería, and ested in the SME segment but also fi nd it profitable. Schmukler 2010). These strategies and technolo- Banks rely on various transactional technologies to gies include credit scoring, in which banks use hard screen the creditworthiness of their SME customers. information from credit registries or bureaus to Large international banks have several comparative determine the likelihood of loan repayment; asset- advantages in dealing with the SME segment, such as based lending, which relies on assets pledged as col- economies of scale or superior business models and lateral; factoring, in which banks purchase a fi rm’s risk management systems. The authors argue that accounts receivable at a discount; and leasing/fi xed- the ability of foreign banks to serve many SMEs in asset lending, in which banks rely on valuations of a different countries using superior business and risk fi rm’s fi xed assets that are either owned by the fi rm management technologies gives them a competitive (in the case of leasing) or pledged as collateral (in edge over other banks because they can compensate the case of fi xed-asset lending). This effort of for- more easily for the costs of developing new products eign banks to develop and implement new screening geared toward SMEs while exploiting larger econo- and lending technologies is consistent with evidence mies of scale and scope. Ongena, Popov, and van Horen (2016) show data security, risk management, mobile bank- that during the European sovereign debt crisis ing, and alternative currencies. In principle, of 2010–12, domestic banks were more likely digital financial services, especially those pro- to increase sovereign debt holdings than for- vided via mobile telephony, hold the promise eign banks when governments had to roll over of deepening financial inclusion to market seg- large amounts of debt. This finding suggests a ments that have been underserved (Ahmed and role for foreign banks in breaking the harmful others 2015). Fintech is likely to facilitate the sovereign bank loop. provision of financial services and affect the On the technology side, today fintech is re- ways in which banks compete with each other shaping who has access to banking services, (and with other nonbank providers of financial and foreign banks are likely to play an impor- services) for all market segments and across tant role in this process. Initially, fintech helped geographical boundaries, which could have financial institutions to speed up transactions broader implications for access, efficiency, and at a lower cost, whereas the most recent tech- financial sector stability (see a more in-depth nologies include a variety of services such as discussion of fintech in chapter 3). 64 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Although fintech could significantly alter Meanwhile, the ratio of debt to liabilities the financial inclusion landscape, it also could (measured by local deposits to total liabilities) entail new risks. A key challenge going for- has remained higher for foreign banks from ward is how to regulate and monitor an in- developing countries over the past decade dustry with such exponential growth. If regu- (panel c). And whereas before the crisis, for- lation is redundant or excessive, the potential eign banks from emerging economies earned that fintech has to promote overall financial a higher share of income from interest than inclusion may be hindered. And yet, policy foreign banks from developed countries, this makers need to adopt and monitor regula- pattern reversed starting in 2007 (panel d). tion that will keep pace with the fast speed As for the health of their portfolios, although at which fintech is growing. The full set of the nonperforming loan (NPL) ratio of foreign risks, which are explored in detail in chapter banks from developing countries improved 3, are not yet understood. They range from over time, during the crisis years NPLs in- data security and cyber risk to regulatory creased substantially for all banks, particu- arbitrage from rules that are not consistent larly for foreign banks from developing coun- across countries or even companies (World tries. Interestingly, in recent years the NPLs of Economic Forum 2016a). foreign banks from developing countries have Another recent development that can declined, even to levels lower than those of change the role of foreign banks is the in- banks from high-income countries (panel e). creasing importance of South–South banking. By contrast, the Z-scores of foreign banks Since the global financial crisis, the roster of from high-income countries have been catch- international banks in developing economies ing up to the levels of developing country for- has been changing. Although foreign bank- eign banks (panel f). ing assets in developing economies continue The recent trends in South–South bank- to grow as financial systems deepen, the pres- ing will likely influence who gets credit. Since ence of developed economy banks, as mea- the global financial crisis, the composition sured by the number of local bank subsidiar- of foreign banks has changed substantially. ies, has been in decline since 2009, according Whereas banks from developing economies to the Foreign Bank Ownership Database have been increasing their presence abroad, (Claessens and van Horen 2015). In the wake most of the exits from markets have been by of this retrenchment, banks from regional fi- banks from OECD countries. These trends nancial centers (Hong Kong SAR, China and may have an impact on who gets credit; Singapore) as well as emerging economies relative to a “North–South” foreign bank, a (China, Colombia, Russia, and South Africa) “South–South” foreign bank may be more fa- have steadily expanded into developing mar- miliar with the cultural, legal, political, and kets (box 2.10 discusses the expansion abroad economic environments of the host country of the largest Chinese banks). and thus may be better suited to overcome Even though foreign banks from emerging the common challenges that foreign banks economies tend to be smaller than their high- face when lending to smaller and more infor- income country counterparts, their overall mationally opaque segments (Mian 2006). A performance has been similar since the global recent cross-country study using firm-level financial crisis. In terms of profitability, the re- data finds that a foreign bank presence is turn on assets of foreign banks from emerging more strongly linked to higher rates of busi- economies has followed closely those of banks ness formation when those banks are head- from high-income countries over the years.18 quartered in developing countries. However, As for the size of their credit portfolios, since banks from developing countries are better the global financial crisis foreign banks from able to spur business formation in industries developing countries have been growing their that rely on standardized inputs, which po- lending at faster rates than their high-income tentially have fewer agency conflicts (Alfaro, competitors (see panels a and b of figure 2.2). Beck, and Calomiris 2015). GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 65 BOX 2.10 The Global Expansion of Chinese Banks With commercial banking assets totaling $24.2 tril- Because of its cultural similarity, political con- lion in 2015, China is home to one of the largest bank- nectedness, and geographical proximity, as well as ing systems in the world.a As trade and investment its established fi nancial industry, Hong Kong SAR, ties strengthen in the global economy, Chinese banks China has been host to many of the earliest affi li- are beginning to create a global financial services net- ated overseas offices of Chinese banks. Around the work that supports domestic clients and contributes time of the Great Depression, the Bank of China to the financial development of host countries. entered global financial centers to gain access to Data collected from the annual reports of the five foreign currency clearance and security trading. largest commercial banks (LCBs) in China reveal Its banking offi ces in London, Luxembourg, New a steady increase in their brick-and-mortar opera- York, Singapore, and Tokyo would in the fol- tions abroad from 2005 to 2015.b As figure B2.10.1 lowing decades become regional hubs of Chinese illustrates, the LCBs had by 2015 established 153 banking operations. Following China’s accession branches and subsidiaries in 50 overseas jurisdic- to the World Trade Organization (WTO) in 2001, tions, 35 of which were located in 19 developing its banking presence expanded from regional host countries.c The bank branch presence in developed countries (such as Australia, the Republic of Korea, countries has rebounded sharply since a temporary and Russian Federation) to Western Europe, Tur- setback after the global fi nancial crisis in 2007–09. key, the Gulf Cooperation Council (GCC) countries, Subsidiaries have increasingly penetrated markets Latin America, and several countries in Sub-Saharan in Latin America and the Caribbean, in addition to Africa. In recent years, commensurate with China’s those in Europe and Asia and the Pacific. The num- fundamental role in global trade, the international- ber of subsidiaries in developing countries more than ization of Chinese banks has facilitated the use of tripled during these years.d FIGURE B2.10.1 Chinese Banks in the World: A Snapshot of Chinese Large Commercial Banks, 2005–15 a. Global subsidiaries and branches by type of host country b. Developing country hosts 160 20 16 2 1 No. of subsidiaries and branches 19 120 15 No. of host countries 5 5 2 11 80 5 79 10 10 2 3 2 51 2 41 2 40 5 8 39 5 6 27 29 0 0 2005 2010 2015 2005 2010 2015 High income, subsidiary Developing, subsidiary East and Asia and Pacific High income, branch Developing, branch Europe and Central Asia Latin America and the Caribbean South Asia Sub-Saharan Africa (box continued next page) 66 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 2.10 The Global Expansion of Chinese Banks (continued) FIGURE B2.10.1 Chinese Banks in the World: A Snapshot of Chinese Large Commercial Banks, 2005–15 (continued) c. Subsidiaries in developing countries 20 1 15 6 No. of subsidiaries 10 1 1 7 4 5 1 3 4 5 0 1 2005 2010 2015 East and Asia and Pacific Europe and Central Asia Latin America and the Caribbean Sub-Saharan Africa Sources: 2016 Annual Reports of Agriculture Bank of China; Bank of China; Bank of Communications; China Construction Bank; Industrial and Commercial Bank of China. the yuan as an increasingly important currency for LCBs participated in lending syndications and cross- settlements (Eichengreen, Walsh, and Weir 2014). border security issuances for clients in the infra- Associated with $1.5 trillion in overseas assets structure, energy, natural resources, and telecom- (out of a gross total of $12.1 trillion), in 2016 the munication sectors, undertaking major international overseas business portfolio of Chinese LCBs included endeavors. Altogether, the overseas business contrib- investment loans, project loans, trade fi nance, and uted to 7.5 percent of the aggregate pretax profit of fi nancial consulting (CBRC 2016a).e In addition, the LCBs as a group (PwC 2016). a. Including large commercial banks, joint stock commercial banks, urban and rural commercial banks, and foreign banks. b. Large commercial banks, as categorized by the China Banking Regulatory Commission (CBRC), include the Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China, and Bank of Communications. They represent the majority of the international Chinese banking presence. In 2015 joint stock commercial banks as a group established seven branches in Luxembourg; Hong Kong SAR, China; Singapore; and the United States. c. Argentina, Brazil, Cambodia, India, Indonesia, Kazakhstan, Lao People’s Democratic Republic, Malaysia, Mexico, Myanmar, Panama, Peru, the Philippines, Russia, South Africa, Thailand, Turkey, Vietnam, and Zambia. d. In a regulatory and supervisory context, home countries exert more control over overseas branches than subsidiaries. This is often one consideration when banks expand abroad. Box 2.1 offers further discussion on foreign bank entry via branches and subsidiaries. e. A 2016 assessment of global systemically important banks (G-SIBs) by the Basel Committee on Banking Supervision indicated that the LCBs’ consolidated cross-jurisdictional activities in 2015 amounted to $1.1 trillion in claims and $1.6 trillion in liabilities (BCBS 2016). GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 67 FIGURE 2.2 Trends over Time of Foreign Bank Subsidiaries in Developing Countries by the Type of Country in Which Each Bank Is Headquartered, 2001–13 a. Return on assets b. Credit growth 3.0 60 2.5 50 2.0 40 Percent Percent 1.5 30 1.0 20 0.5 10 0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 00 01 02 03 04 05 06 07 08 09 10 11 12 13 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 c. Local deposits to total liabilities d. Interest income 100 80 90 75 80 70 Percent Percent 70 65 60 60 50 55 40 50 00 01 02 03 04 05 06 07 08 09 10 11 12 13 00 01 02 03 04 05 06 07 08 09 10 11 12 13 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 e. Nonperforming loans f. Bank Z-score 12 60 10 50 8 40 Percent Percent 6 30 4 20 2 10 0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 00 01 02 03 04 05 06 07 08 09 10 11 12 13 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 High-income Developing Source: Analysis is based on Claessens and van Horen Foreign Bank Ownership Database, matched with consolidated Bankscope statements (Claessens and van Horen 2015). Note: “High-income” and “developing” categories correspond to bank subsidiaries in developing countries headquartered in high-income and developing countries, as defined by the World Bank. Figures present averages of the indicators weighted by bank assets. The gray area indicates the global financial crisis period. 68 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Meanwhile, more lax regulation in the domestic banks to anticipate trade risks from home countries of South–South banks may both importers and exporters. This could al- bring higher risks to the host country. In low them to better overcome information terms of stability, the home country of a for- asymmetries and contracting problems. eign bank matters. Although foreign banks Studies have also found that a foreign can spread shocks from their home countries bank presence enables and fosters FDI in a to a host economy, this transmission has been host economy. In developing countries, FDI found to be stronger among foreign banks may be limited by the lack of information from home countries with lax financial regu- about the local market, or by the absence of lation and weaker institutional environments, bank financial expertise. Foreign banks, with and those banks are more likely to be head- expertise in global transactions and plausibly quartered in less developed countries. Foreign more sophisticated lending technologies than banks from developing countries may bring local banks, can help overcome these barri- better knowledge on how to operate in a ers and thus enable FDI in a host economy. weaker and more informationally opaque en- Recent studies have shed light on the role of vironment, but they may be poorly supervised foreign banks in promoting FDI. Ongena, Qi, in their home country, which could translate and Qin (2014) collected data on FDI and the into more instability for the host economy presence of foreign banks by source economy (Claessens and van Horen 2007). for 12 regions in China over a period of 14 years, and they found that the level of FDI in a region indeed increases as the network Other Real Effects of foreign banks expands. Using the instru- Foreign banks also play an important role in mental variables approach, they show that the trade sector of the host economy. Several their results are robust to instrumenting for empirical studies show that firms in countries the presence of foreign banks with the tim- with a higher level of financial development ing of the regional phasing out of the local are not only more likely to export but also limits for foreign banks on local currency more likely to export in sectors that are more business.19 Foreign banks may also facilitate dependent on external finance (Beck 2002; investment by firms from their home econ- Manova 2013). Moreover, in less developed omy in which they operate. Poelhekke (2015) economies, firms in sectors with more external finds evidence supporting this view. Using financial dependence tend to export more as data on FDI and exploiting the large differ- the share of foreign banks in the economy in- ences in the deregulation of banking sectors creases, and particularly when foreign banks across economies and time, Poelhekke shows are headquartered in the importing country that the entry of foreign banks in a host (Claessens, Hassib, and van Horen 2014). economy was followed by an expansion in This finding suggests that foreign banks may nonfinancial FDI from firms in the same home have an edge in supplying specific financing economy. needs to exporting firms. This edge may be a Foreign banks may also have a direct ef- result of the more advanced lending technolo- fect on firm innovation. Bircan and De Haas gies that foreign banks tend to use or of the (2015) find that Russian firms that receive ability of foreign banks to diversify risks (be- credit from foreign banks are more innova- cause of their scale and global nature), which tive. Innovation is not only higher in localities may allow them to specialize in specific trade- with a greater number of foreign banks, but related products such as letters of credit. This also conditional on borrowing; firms that bor- finding also indicates that foreign banks can row from a foreign bank innovate more than facilitate trade through an information chan- firms that borrow from domestic banks.20 nel (see box 3.2 in chapter 3). Foreign banks, Although the presence of foreign banks particularly if they are headquartered in the may have long-term effects on the economy of importing country, may be better able than their host country, studies have found mixed GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 69 results. Many studies have analyzed the indi- especially, resolving a global bank. One key rect links between foreign banking and long- difficulty is that national sovereign countries term growth, but very little attention has been operate within globalized and international devoted to the direct links between banking markets (Goodhart 2013). In these intercon- openness and economic growth. Early stud- nected markets, bank failures in one country ies that investigated the relationship between may result in substantial externalities in other foreign bank presence and growth at the countries. For example, when a bank with a macro level were inconclusive. Demirgüç- high share of foreign deposits fails, depositors Kunt, Levine, and Min (1998) regressed real abroad may be at risk. However, such costs GDP per capita growth on foreign assets (or may not be considered by domestic supervi- foreign bank presence) while controlling for sors, leading to inefficient decisions (Beck, other factors associated with growth, and Todorov, and Wagner 2013).22 This is where they found no significant direct effects. Later the value of international regulation lies. To studies tried to address the endogeneity issues avoid these distortions and externalities, the present in these studies by refining the estima- regulation, supervision, and resolution of tion techniques. Employing dynamic panel global banks should occur at a supranational estimators on a sample of 28 countries be- level. tween 1994 and 2003, Bayraktar and Wang However, there is a basic trade-off when se- (2008) reveal that the asset share of foreign lecting the optimal international financial ar- banks has a significant positive effect on GDP chitecture. As Beck, Silva-Buston, and Wagner per capita growth. Other studies have ana- (2015), discuss, if all countries were identical, lyzed the causal impact of the liberalization it would be easy to agree on the right model of intrastate branching in the United States for international regulation. However, the by exploiting the differentiated responses greater the differences among countries (for across states and time. For example, Beck, example, in their legal and regulatory systems, Levine, and Levkov (2010) look at the con- or in their exposure to costs in bank failure), sequences for the distribution of income and the higher is the cost of closer cooperation. find boosted incomes for the lower part of the Therefore, the larger these differences across distribution, whereas Huang (2008) studies countries, the less desirable and less effective economic growth, finding limited evidence of supranational supervision becomes. Beck, higher growth. Using an international panel, Silva-Buston, and Wagner (2015) argue that Bremus and Buch (2014) analyze whether fi- as externalities become more important and nancial openness may affect economic growth failure costs are more similar between coun- through “granularity” in the banking sec- tries, the more likely it is that supranational tor—that is, the propensity of idiosyncratic supervision is preferred over national supervi- shocks affecting large banks to affect in turn sion. As discussed later in this section, this ba- the aggregate economy.21 The results suggest sic trade-off can serve as a general framework that financial openness is negatively associ- for assessing the effectiveness and suitability of ated with economic growth (but this is mostly different forms of cross-border integration of driven by countries with low financial depth), bank supervision. and they find evidence that granular effects Until now, international supervisory co- exist and are stronger in financially closed operation has been the preferred way to deal economies. with the geographic mismatch between global banks and national supervision. For more than 40 years, supervisors have cooperated CROSS-BORDER APPROACHES not only by harmonizing regulations and su- TO REGULATION, SUPERVISION, pervision standards but also by exchanging AND RESOLUTION information on individual cross-border finan- Authorities face a complex challenge when cial institutions. Exchanging information on it comes to regulating, supervising, and, financial institutions helps the host country 70 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 to evaluate the risk profile of a foreign bank resolution phase, when distress, chaos, and based on its activities in the home country, improvisation were common. During the cri- and such information enables it to take the sis, supervisory cooperation broke down, and actions needed to deal with potential risks. many banks had to be resolved along national Exchanging information is also crucial for lines. The reasons for these breakdowns are preventing significant operational risks, such complex, and a large body of literature has as money laundering and terrorism financing. analyzed them. One lesson from the financial The Basel Committee on Banking Super- crisis is that the existing cooperation arrange- vision has been the primary global standard- ments seemed appropriate in normal times, setter for bank regulation and supervision. Its but they failed in times of crisis, when rapid, mandate is to improve the regulation, super- collaborative responses were needed. The in- vision, and practices of internationally active ternational rules of cooperation laid out in banks, and thus seeking to increase global fi- memoranda of understanding between au- nancial stability. Supervisory cooperation, de- thorities were, and remain, nonbinding. These signed by the Basel Committee, is based on an nonbinding approaches clearly did not suf- agreed-on division of responsibilities among fice during bad times, when cooperation was prudential supervisors. Specifically, supervi- significantly reduced and most cross-border sors in the home country are responsible for resolutions were poor (Claessens 2016). One consolidated supervision, and supervisors in example was the resolution of Fortis, the larg- the host country are responsible for supervi- est Belgian bank with significant operations sion on an individual or subconsolidated ba- in the Netherlands and Luxembourg. Regula- sis for financial institutions operating in their tors from the Netherlands, Luxembourg, and country. Cooperation should take place at all Belgium decided to inject capital into the fail- stages of supervision (prevention), early reme- ing bank, until the Dutch government nation- diation (recovery), and resolution (crisis man- alized its Dutch assets, which led to an unco- agement). It can take different forms, includ- ordinated resolution along national borders ing supervisory colleges, bilateral cooperation, (Wiggins, Tente, and Metrick 2014). The sale regulatory harmonization, and more recently of Belgian Fortis to BNP Paribas was chal- established crisis management groups.23 lenged in court by its shareholders, postpon- Nevertheless, coordination across coun- ing finalization of the deal (IMF 2010). tries is challenging, and the resolution of Another important reason for the break- global banks is extremely complex. Effec- down in international cooperation was the tive coordination across countries of regula- lack of coordinated resolution mechanisms tion and supervision as well as intervention that could minimize the impact of distressed in case of financial distress are very difficult financial institutions on global financial sta- to achieve because countries have different bility. A core feature of a stable system is that policy preferences and incentives.24 When for- financial institutions must be able to fail in an eign banks are systemic in host countries but orderly fashion, which means without exces- not large in their home country, as in many sively disrupting the financial system; without developing countries, the incentives of foreign interrupting, when possible, the critical func- authorities to cooperate may be low (Claes- tions that banks provide; and without expos- sens 2016).25 The reason is simple: even when ing taxpayers to losses. Because of the absence the risks associated with weak supervision are of specific instruments to resolve systemically high, if the costs are largely borne by the host important banks in an orderly way, the tools country then regulators in the home country, used to resolve cross-border banks were last- may have little incentive to act. minute, ad hoc interventions involving pub- The need to improve the current arrange- lic support.26 Global banks that failed or ran ments for cooperation was clear during the into trouble during the global financial crisis global financial crisis, particularly in the were largely supported by the governments of GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 71 host economies. As Beck, Todorov, and Wag- detail other initiatives aimed at reducing the ner (2013) document, supervisors were more cost of future financial crises. likely to intervene if banks’ equity was in the Structural banking reform measures can hands of foreigners, and incentives to inter- be used to limit activities that are too risky vene were lower if the deposits or assets of a or whose risks are too complex to measure. bank were held abroad (that is, by nonlocals). Because price-based regulations such as capi- Since the global financial crisis, policy tal requirements or leverage ratios may be makers have been addressing this lack of en- inadequate for measuring the risks associ- forceable and effective mechanisms for crisis ated with certain activities, structural reforms resolution of cross-border banking groups have been proposed that move risky, complex in various ways. Since the crisis, regulation businesses into stand-alone subsidiaries or of cross-border flows has become more re- prohibit these activities altogether. An impor- strictive, and informal barriers in the form tant aim of these measures is to limit conta- of ring-fencing have increased. A report by gion from financial markets and thus limit the the IMF (2015) emphasizes that the destabi- benefits of public guarantees to core banking lizing effects of cross-border lending during services, such as deposits, lending, and pay- shock episodes are best confronted by mutu- ments (Viñals and others 2013). U.S. ap- ally compatible resolution frameworks that proaches have favored the outright separation could provide a global safety net, preventing of investment banking and trading activities, the ad hoc imposition of ex post ring-fencing whereas European approaches to ring-fencing by prudential supervisors. Regulators and su- entail subsidiarizing them.27 Although struc- pervisors should also be aware that ex ante tural separation may be warranted for some ring-fencing measures are likely to affect the activities, regulators should also recognize operational structures and the roster of for- that this may curtail the ability of banks to eign banks that operate in a host country. diversify risks across activities to some extent The greater focus on crisis management and, perhaps more importantly, could push and resolution is reflected in the policy re- risks outside the formally regulated financial sponse by the Group of 20 and the Financial sector to shadow banks whose regulation Stability Board (FSB). Significant progress has and supervision would need commensurate been made in strengthening cooperation by improvement. establishing crisis management groups, which But more importantly, the global finan- have been set up for systemically important cial crisis highlighted the need to improve institutions, and by creating recovery and the cross-border regulation and supervision resolution plans. Another example is “bail- of global banks, as well as their resolution in” mechanisms, which consist of writing off in case of stress. The existing cross-border banks’ liabilities or converting them to equity, resolutions and cross-country cooperation allowing the institution to continue as a going were poor because of the so-called financial concern while giving the authorities’ time to trilemma. According to Schoenmaker (2013), reorganize or wind down parts of the busi- a trilemma entails the incompatibility of pur- ness in an orderly manner without the need suing financial stability and financial integra- for taxpayer support. Claessens (2016) de- tion while maintaining national resolution scribes specific regulations passed after the authority. Any two of these policy objectives global financial crisis and intended to better can be combined, but not all three. Thus, regulate and supervise international banks. taking into account these trade-offs, regula- More intense monitoring of large global tors need to decide on a supervisory coopera- banks and their risks is now in place, and pre- tion model that maximizes welfare. There is ventive measures, such as total loss absorbing a wide spectrum of supervisory cooperation capacity (TLAC) in case of financial distress, models, which can be positioned along a have been implemented. Box 2.11 discusses in continuum of increasing loss of sovereignty. 72 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 2.11 Decentralized Global Banks and Multiple-Point-of-Entry Resolution One key challenge arising from the recent fi nancial Under the decentralized model, global retail banks crisis that has not yet been solved is how to deal with operate abroad with legally independent subsidiar- global systemically important banks (G-SIBs). The ies with autonomous capital and liquidity manage- failure of such too-big-to-fail institutions could be ment, relying mainly on local currency–denominated devastating for the fi nancial system and the economy deposits. The subsidiaries are supervised by the local as a whole. However, bailing out institutions entails authorities and protected by the host country deposit large costs and may give them an incentive to increase guarantee scheme. The parent provides group strat- their risk taking and grow ever larger (Bolton and egy guidelines, such as setting the global risk appe- Oehmke 2015). tite framework, as well as a common culture, gover- In the aftermath of the global financial crisis, nance, and control. Intragroup connections are very regulators decided to put in place a new bank resolu- limited. Although support from the parent to the tion framework aimed at reducing the cost of future subsidiaries is possible, it is exceptional, temporary, banking crises. This framework requires sharehold- and at market prices. ers and creditors to absorb losses while avoiding the Recent studies—such as those by Kamil and Rai use of taxpayer money (the European Union’s Bank (2010) and Feyen and others (2014)—uncovered the Recovery and Resolution Directive is one example resilience of decentralized banking during the global of this arrangement). One of the main challenges of financial crisis and highlighted its stabilizing role this new way of handling crises is the cross-border in limiting contagion from connected countries. In dimension, in particular for global banks, which the 2011 deleveraging episode, for example, Latin would be reflected in the resolution strategy selected American subsidiaries of European banks suffered by regulators. relatively little liquidity contraction, in contrast to The resolution strategy for global banks should their counterparts in Europe and Central Asia (ECA), be consistent with the way in which they operate. which were more reliant on parent funding (see figure Broadly speaking, global banks tend to follow either B2.11.1). The vulnerability of the subsidiaries in the a centralized business model or a decentralized one. ECA region to contagion necessitated the Vienna Ini- FIGURE B2.11.1 Liquidity and Cross-Border Funding of European Bank Subsidiaries in Europe and Central Asia and Latin America and the Caribbean Regions b. Change in cross-border claims on a. Liquidity of European bank subsidiaries, 2005–13 bank counterparties, 2004–16 40 350 35 300 30 250 Liquid assets (% of total) 25 200 Percent 20 150 15 100 10 50 5 0 0 –50 2005 2007 2009 2011 2013 Europe and Central Asia Latin America Europe and Central Asia and the Caribbean Latin America and the Caribbean 2004–08 2008–12 2012–16 Sources: Staff calculations, based on Bankscope (database). Sources: Álvarez, García, and Gouveia 2016, based on Bank for International Note: The gray area in panel a indicates the global financial crisis period. Settlements International Banking Statistics. (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 73 BOX 2.11 Decentralized Global Banks and Multiple-Point-of-Entry Resolution (continued) tiative, which was given the goal of improving home- such an arrangement may be incompatible with the host coordination and safeguarding financial stability interests of national regulators because they would in emerging Europe. Cerutti and others (2010) argue, prefer to ring-fence their national fi nancial systems. however, that such a decentralized model may also The authors’ analysis shows that the more decentral- lead to inefficiencies, such as reducing the ability to ized the operations of a global bank, the more effi - relocate bank capital internationally and increasing cient the MPE resolution is relative to the SPE one. the size of capital buffers at the subsidiary level. The MPE resolution strategy is better adapted The Financial Stability Board (FSB) has defi ned to decentralized banks funded with local deposits two resolution approaches for global banks: under the legal structure of subsidiaries, with little or no intragroup positions and decentralized capital • Single point of entry (SPE). Resolution power is and liquidity management. a Local authorities that exercised at the top level by the supervisory author- already supervise the local subsidiary on a business- ity of the parent, with losses absorbed within the as-usual basis would retain this feature when the banking group. To reassure host banking authori- bank is failing or likely to fail. Local authorities ties, this strategy normally requires total loss- would also be the leaders in any resolution. The absorbing capacity (TLAC) to be internally prepo- home authority would mainly act as a coordinator sitioned by the parent bank. in case several subsidiaries have to be resolved at • Multiple point of entry (MPE). Resolution power the same time, which is very unlikely because of the is distributed to different authorities relevant to diversification inherent in this model. the entire banking group, along dimensions of geo- Although there is no unique foreign bank busi- graphic location or business line. Each subsidiary ness paradigm, the MPE resolution strategy is more is then resolved by the local authority according to appropriate in the ring-fencing context, where the the applicable resolution frameworks. bail-in paradigm still faces the test of practical imple- mentation. It is important that regulations acknowl- Using a simple model, Bolton and Oehmke (2015) edge the specificities of the MPE model and do not highlight the trade-offs that arise in cross-border penalize it by requiring internal TLAC (which com- resolutions of global banks, including the political plicates the functioning of this model by increasing constraints faced by national regulators. Their main intragroup positions) or by imposing consolidated results suggest that even though an SPE resolution requirements over and above those decided by local is in principle more efficient than an MPE solution, authorities. a. See, for example, Faia and Weder di Mauro (2015) for a recent theoretical approach to optimal resolution design. At one end of the spectrum is the universal capital and liquidity globally, potentially hin- approach, with legally binding frameworks, dering the benefits that global banks may loss of sovereignty, and centralized decision bring to the host economy. making. An example of this approach is the An alternative model for supervisory co- European banking union (box 2.12). At the operation is a more intermediate approach. other end of the spectrum is a more territo- In the years before the onset of the global rial approach, consisting of a noncooperative financial crisis, countries were moving to- solution whereby each unit of a global bank is ward a more universal approach to super- resolved according to local regulations (Claes- visory cooperation. Since the crisis, a more sens 2016). Although there is no international territorial view has prevailed. Countries burden sharing under the latter approach, it have adopted barriers to limit cross-border would be costlier for global banks to allocate finance, such as macroprudential measures 74 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 2.12 The European Banking Union The European Union’s (EU’s) banking union was ing or in the use of the fund itself. The fund will launched in 2012 in response to the deterioration of be built up over a 10-year period by contributions credit conditions during the European debt crisis. reaching the target funding level of at least 1 percent Under this arrangement, the responsibility for bank- of covered deposits. During an eight-year transition ing policy passes from the national level to the euro period, national contributions are still earmarked area level. As of 2016, the union had two main pil- and held in national compartments, after which the lars, the Single Supervisory Mechanism (SSM) and SRF will be set up as a truly European fund. Even the Single Resolution Mechanism (SRM). A third pil- though the fund will be small, it can help to meet the lar, European Deposit Insurance, is currently under unavoidable costs of resolution, and the main capital development. deficiency can be borne by the total loss-absorbing The Single Supervisory Mechanism is part of the capacity (TLAC) liabilities. European Central Bank (ECB). Its main goals are In November 2015, the European Commission ensuring the safety and soundness of the European adopted a legislative proposal for a European Deposit banking system, increasing fi nancial integration and Insurance Scheme (EDIS), which will be fully opera- stability in Europe, and conducting consistent super- tional by 2024. EDIS would create a centralized euro vision across participant banks. It directly supervises area–wide deposit insurance scheme that would com- some 130 significant banks, which account for about prise national deposit guarantee schemes plus a Euro- 85 percent of the total banking assets in the euro pean deposit insurance fund built over eight years. area, and it is empowered to intervene directly in less The existing national deposit guarantee funds would significant institutions. The SSM licenses all banks remain in place as part of EDIS, which would be built in the euro area. It works with national authorities, up by coinsuring national deposit guarantee schemes and it currently is limited to the euro area. The SSM and pooling the available funds for payouts over time relies on local supervisors to collect information and without requiring an overall increase in bank contri- perform on-site inspections. butions. EDIS would be developed in three stages: The Single Resolution Mechanism was put in (1) a reinsurance scheme for the first three years, place to ensure that the resolution of credit institu- providing liquidity assistance and limited loss absor- tions facing fi nancial difficulties is carried out effi - bance of the national schemes; (2) a coinsurance ciently, thereby reducing its costs to the real econ- scheme for four years, until 2024, under which EDIS omy. In the resolution of a systemically important would absorb a progressively larger share of losses of institution, the costs of failure should not be borne the national schemes; and (3) a fi nal stage, in which by taxpayers. Instead, the EU’s banking union will EDIS would fully insure deposits and cover all liquid- set up a Single Resolution Fund (SRF) that has no ity needs and losses in the event of a payout or resolu- national elements either in the calculation of its fund- tion procedure and protect deposits below €100,000.a a. At the time this chapter was drafted, political resistance to EDIS was continuing, and implementation had not yet been scheduled. and countercyclical buffers. However, the in- often bilateral and nonbinding cooperation tended impact of these measures is difficult to models, such as the Association of Southeast achieve without coordination with authorities Asian Nations (ASEAN) or the West African in the countries in which foreign banks are Economic and Monetary Union (WAEMU), headquartered.28 Nevertheless, an intermedi- are examples of the intermediate approaches ate model of cooperation, in which some ele- discussed in boxes 2.13 and 2.14. As Claes- ments of the universal approach are adopted sens (2016) suggests, the intermediate ap- (such as resolution procedures), may be the proach could aim to have a “concordat,” an preferred model for many countries. Looser, international agreement with a framework GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 75 BOX 2.13 Intermediate Cooperation Approaches: The ASEAN and Australia– New Zealand Cases A recent, looser form of cooperation is the ASEAN Another example of legally binding cooperation Economic Community, which was established at the is the supervisory cooperation between Australia end of 2015. The 10 member states of the Association and New Zealand. The largest Australian banks of Southeast Asian Nations (ASEAN) entered the dominate the fi nancial system of New Zealand.c As ASEAN Banking Integration Framework in March a result, both countries have a very close home–host 2015.a Member states may enter bilateral agreements relationship. The cooperation and information shar- that allow qualified ASEAN banks to operate in part- ing between the Australian Prudential Regulation ner countries on the same terms as domestic banks. Authority (APRA) and the Reserve Bank of New The criteria and reciprocal terms for bank access Zealand (RBNZ) are extensive. This cooperation are negotiated bilaterally. This agreement is part of has been further reinforced by a 2006 amendment ASEAN’s efforts to create a single economic market. to the RBNZ Act that legally obliges the RBNZ to It grants ASEAN banks greater market access than cooperate and consult with the fi nancial supervisory non-ASEAN banks, but it remains based on a net- authorities in Australia to try to avoid actions that work of bilateral agreements. The ASEAN Banking may negatively affect fi nancial stability in Austra- Integration Framework is fundamentally different lia. The Australian Banking Act contains similar from the European Union’s “single passport regime.” provisions. Their main similarity is that they both seek to make market access for banks less burdensome.b a. ASEAN is a political and economic organization comprising Brunei, Cambodia, Indonesia, Lao People’s Democratic Republic, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. b. The European passport principle allows a bank that is licensed in one EU member state to open branches in other member states by simply notifying the host country before opening the branch. The relevant host authorities do not have the right to refuse the establishment of the branch if it has been authorized by the home country and cannot force the branch to take another legal form. c. Australia’s big four banks—the ANZ, Commonwealth Bank, National Australia Bank, and Westpac—control almost 90 percent of the assets of New Zealand’s banking system. similar to that of the Basel Committee on countries and emerging markets do not have Banking Supervision but focused on crisis much representation in the relevant bod- management and, importantly, with explicit ies and forums, which creates problems for incentives for collaboration, credible resolu- them in the design and implementation of tion processes, and clarity on cost sharing in regulation and supervision arrangements (FSB a resolution. 2011). These obstacles are particularly impor- Nevertheless, obstacles to cross-border tant because of the growing trends in region- resolution, particularly among developing alization and South–South banking. countries, continue to exist. For cross-border In the years to come, South–South entry cooperation agreements to work, both host and more regionalization of foreign banks and home authorities need to cooperate fully will substantially shape cross-border supervi- and commit to legislative action as necessary sory and regulatory arrangements. As South– to empower resolutions. As noted by the Fi- South banking and bank regionalization nancial Stability Board (FSB 2013), emerg- continue to develop, the benefits and risks of ing and developing countries may not have international banks may also change, with adequate supervisory expertise, capacity, or important consequences for their regulation resources to respond to postcrisis global regu- and supervision. The new generation of for- latory incentives. Moreover, many developing eign banks from other developing countries, 76 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 2.14 Intermediate Cooperation Approaches: The WAEMU Case Cross-border banking has been increasing in Africa. result, the standards set by the Basel Committee may As of 2014, there were 104 active cross-border banks not be appropriate for African banking cooperation. with at least one branch or subsidiary outside their As noted by the Financial Stability Board (2013), home countries.a The recent growth of pan-African these countries may not have adequate supervisory banks has transferred the risks and benefits of cross- expertise or resources to respond to postcrisis global border banking from European to African policy regulatory incentives. When compared to the level of makers. Regional integration of African banks brings cooperation in the European or Australia–New Zea- many benefits but also a cost of contagion, hence the land examples, WAEMU is at its early steps. Beck, need for increased supervisory cooperation. That is, Fuchs, and others (2014) discuss that information potential instabilities arising from pan-African banks exchange is still very weak in Africa, and it would will need to be handled collaboratively rather than be a fi rst step to create a basic data set, and hence by individual supervisors. facilitate better supervisory cooperation. The West African Monetary Union Banking Member countries of the WAEMU are affected Commission, founded in 1990, is overseen by the by frequent and often idiosyncratic shocks, such as governor of the Central Bank of West African States natural disasters or political instabilities. The macro- (BCEAO). As a further step for supervisory coop- economic volatility makes the domestic financial eration, the treaty for the West African Economic sector more unstable. Hence, policies must be based and Monetary Union (WAEMU, also known by on bilateral or subregional agreements rather than its French acronym, UEMOA) was signed in 1994. being unique across all countries in the region. In the The member states are Benin, Burkina Faso, Côte case of West Africa, an increasing level of fi nancial d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and integration coexists with these heterogeneities across Togo. The focus of the WAEMU and its Banking countries. More specifically, fi nancial systems have Commission has been the banking sector, but this is developed differently in the countries with Anglo- evolving rapidly with the emergence of transnational phone and Francophone cultures. This may suggest a banking groups and microcredit institutions. As of more detailed framework within subregions. Another 2015, the WAEMU banking sector included 127 aspect of the heterogeneity is the ownership struc- credit institutions, including 114 commercial banks ture of banks in African countries. African coun- and 13 other quasi-bank fi nancial institutions.b This tries that are mostly dominated by European banks, amounts to more than 90 percent of all financial for instance Mozambique, may need considerations assets in the region and more than half of regional within the subregions. Security risks may also yield GDP. The WAEMU aims to maintain a common delays in reforms, which creates another problem legal and regulatory framework for the regional for the harmonization goals of WAEMU. Another banking system. Considering the political and concern is that less developed business conditions, regional characteristics of these countries, address- asymmetric information, and weak judicial envi- ing these issues requires different approaches than in ronments impose diffi culties for an effective union developed countries. More specifically, the political in the region. Finally, despite the centralized struc- and institutional characteristics of these countries ture of WEAMU, supervisory decisions made by the are more heterogeneous than in European countries. WAEMU Banking Commission are mostly subject In addition, fi nancial deepening and access, super- to the approval of national agencies. This aspect of visory capacity, and fi nancial infrastructure are dif- the African case differs from the EU’s banking union ferent in Africa than in developed economies. As a model. a. Some of these influential banks of African origin that operate in many African countries outside their home country are Ecobank, United Bank for Africa, Standard Bank Group, Banque Marocaine du Commerce Extérieur, Banque Sahélo-Saharienne pour l’Investissement et le Commerce, and Attijariwafe Bank. b. European Investment Bank, “Recent Trends in Banking in Sub-Saharan Africa: From Financing to Investment,” July 2015. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 77 with more proximity to host countries in bad ways of attracting international banks. terms of culture, economic conditions, and Opening host economies to foreign nonfi- even physical distance, may facilitate commu- nancial firms and providing foreign firms nication and coordination between host and with profit opportunities will attract foreign home country authorities. The rise of foreign banks looking for profits and diversification. banks from developing countries also implies Host countries should, however, avoid offer- that the developing countries that host them ing foreign banks these profit opportunities need to be more engaged with the interna- via weak regulation and supervision because tional financial agenda and need to better this approach will tempt parent banks to in- monitor the activities of their foreign banks. cur excessive risk in host economies, such as Regulators should also be cautious about the through regulatory arbitrage. Thus, for host regionalization of foreign banks because this economies, the best way to avoid being ex- trend could lead to financial repression, ring- ploited as a risk-taking haven is to adopt a fencing, and fragmentation, which could in strong financial regulatory and supervisory turn adversely affect the financial stability of framework and ensure that foreign subsid- the host economy (Claessens 2016). iaries are self-sufficient (with high capitaliza- Regulators must also pay close attention to tion requirements and a high share of fund- fintech and the way it is revolutionizing the ing through retail deposits). Because foreign banking sector. Fintech may bring new chal- branches are mostly under home country lenges to the already-complex supervision regulation, host country authorities should and regulation of foreign banks. Regulators prefer subsidiaries as the mode of entry for in- need to keep pace with the rapid speed with ternational banks. Moreover, a mix of green- which nonbank providers enter the market field and foreign bank subsidiary takeover and digital services are rolled out and the po- investment should be welcomed. Because they tential risks that these changes may entail. are better integrated with the parent bank, greenfields may help more during local down- turns, whereas investment through acquisi- CONCLUSIONS AND POLICY tions may yield greater benefits in response to IMPLICATIONS home country or global shocks. Finally, some The brick-and-mortar operations of interna- diversification of foreign banks’ business tional banks can have important benefits for models may shield host economies from the the higher financial development of a host negative outcomes associated with a specific economy. The entry of foreign banks into a type of activity (for example, a negative shock host economy can increase competition in to fee-based, noninterest, income-generating the banking sector, the performance of lo- activities). cal banks, and overall access to credit. For- Strong regulation and supervision are not eign banks also can provide the host country possible in a weak institutional environment. with a risk-sharing scheme, but, as in all risk- Financial liberalization should be accom- sharing schemes, it is not a one-way relation- panied by institutional reforms that prevent ship; the two sides (parent banks and foreign foreign banks from crowding out incumbents affiliates, or home countries and host coun- without increasing the competitiveness and tries) must support each other during difficult efficiency of the banking sector in the host times. The experience of international banks economy. Financial liberalization should also over the last few decades offers valuable pol- be introduced gradually to allow domestic icy lessons for reaping the benefits of interna- banks to adapt and better compete with new tional banking while keeping the costs at a foreign banks. During home country or global minimum for both sides. downturns, foreign banks will be less likely to Studying the drivers of bank international- retrench from host countries that have solid ization and its consequences reveals good and institutional environments and competitive 78 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 banking systems. Moreover, host economies an open financial system—and universal- with a good information environment and ism—the equitable distribution of bankruptcy effective contract enforcement are likely to costs involving cross-border burden sharing. reap more benefits from foreign banks, as The European SRM is a prospective exam- improved information sharing—through, for ple of the latter approach (Claessens 2016). example, credit registries—can help foreign Although these two approaches may be too banks to lower average lending interest rates extreme for many countries, an intermediate and increase average loan quality.29 model of cooperation that includes some ele- When possible, such as in a privatization ments of the universal approach may be fea- process, host country authorities should con- sible. Ideally, this intermediate model would sider choosing among foreign parent banks as adopt an international agreement on crisis prospective owners. They could try to diver- management that explicitly outlines responsi- sify the roster of home countries and ensure bilities and processes to follow in a resolution. that the prospective parent banks are also di- Ring-fencing is how some local regulators versified and not overly dependent on whole- seek to limit the potentially negative conse- sale funding so they can provide liquidity and quences of having foreign banks. Host author- other support to their subsidiaries even during ities request local liquidity and capital to mini- bad times at home. Host countries can try to mize the impact of external shocks. In terms pick parent banks from home countries with of advantages, this approach provides better effective banking regulations and some prox- incentives for local supervision and no bur- imity to the host country (culturally, institu- den-sharing requirements. Ring-fencing, how- tionally, or in physical distance) to increase ever, is less efficient for financial institutions the stability of the foreign bank subsidiary or because it reduces the benefits of cross-border branch. Host country authorities may also di- banking in the first place, potentially imposing versify across other characteristics of foreign costs in times of stress through possible runs banks, such as their business models. This and liquidity problems. This approach also strategic diversification may be planned at the undermines any cross-border regulation and level of financial sector strategies, rather than supervision incentives, thereby hurting the at the more ad hoc stage of the licensing pro- general openness of financial systems. cess. Finally, a core position in the banking group—in terms of relative size or profitabil- ity—lowers the chances that a foreign bank NOTES will run for the exit in response to a shock. 1. See Čihák, Mare, and Melecky (2016) on Any efforts to shape the roster of foreign the trade-offs between the pursuit of deeper banks must be consistent with a country’s ob- financial inclusion and financial stability. ligations under multilateral and preferential 2. Even though most emerging economies and service trade agreements. A country that pur- developing countries have strengthened their sues this approach would likely need to iden- banking supervision and regulation, they tify a set of objective criteria for evaluating still face various challenges, such as supervi- prospective entrants to ensure that provisions sory capacity constraints or incomplete legal in trade agreements precluding discrimination frameworks (Financial Stability Board 2011). 3. See, for example, Goldberg and Johnson against other countries are not violated. (1990) for the U.S. case and Focarelli and The regulatory and supervisory failures Pozzolo (2000) for an international analysis. during the recent global financial crisis led to Also see Cull and Martínez Pería (2010) for an intensive effort to redesign the regulatory a literature review on foreign bank participa- landscape. Two extreme approaches influenc- tion in developing countries. ing the ongoing policy discussions entail ter- 4. Another example is from Dell’Ariccia and ritoriality—ring-fencing of activities under a Marquez (2006a), who develop a race-to-the- particular authority’s domain, which inhibits bottom model in which they show that com- GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S 79 petition among regulators reduces regulatory sis (and were not just as the result of removal standards, creating competition in laxity in of entry barriers). order to promote their domestic banks. 10. Evidence on the transmission of international 5. See Mian (2006), who relates various distance monetary policy via foreign banks in a par- measures to information, agency, or enforce- ticular country such as Mexico is discussed in ment costs in a developing country environ- box 2.8. ment. 11. See, for example, De Haas and van Lelyveld 6. As highlighted by Claessens (2016), foreign (2006), who confirm the procyclicality of for- banks are likely to select host countries that eign banks for Eastern Europe. have income levels and institutional develop- 12. Other empirical studies analyzing the lending ment similar to or lower than that in their of foreign banks during the global financial home countries. crisis are those by Choi, Gutierrez, and Mar- 7. An extensive number of studies in develop- tínez Pería (2014); Claessens and van Horen ing countries, at both the regional and coun- 2015; De Haas and van Lelyveld (2014); try levels, find evidence that foreign banks De Haas and others (2015); and Mihaljek are more efficient than domestic banks (see, (2011). for example, Bonaccorsi di Patti and Hardy 13. Using individual-level data across 123 dif- 2005; Detragiache and Gupta 2006; Havryl- ferent countries, Allen and others (2012) chyk and Jurzyk 2011; Isik and Hassan analyze the association between financial 2002; Matoušek and Taci 2004; Weill 2003). inclusion measures and different individual However, other studies find a more ambigu- and country characteristics, and they find that ous pattern. For example, in countries with a the share of foreign banks is not significantly limited foreign bank presence, such as India correlated with financial inclusion. This find- and China, differences in efficiency between ing, however, may mask the fact that the domestic and foreign banks are not very impact of foreign banks in a host economy large (Berger, Hasan, and Zhou 2009; Bhat- is not homogeneous across countries and tacharya, Lovell, and Sahay 1997; Sensarma largely depends on the institutional context 2006; Wu, Chen, and Lin 2007). In other of the host economy. studies from Latin America, the findings dif- 14. Also see Detragiache, Tressel, and Gupta fer, depending on the efficiency measure used (2008) for a focus on poor countries showing (Barajas, Steiner, and Salazar 2000; Berger similar results. and others 2005; Crystal, Dages, and Gold- berg 2001; Goldberg, Dages, and Kinney 15. Although a foreign bank presence is nega- 2000). tively associated with credit access in low- 8. Morgan, Rime, and Strahan (2004) illustrate income countries, it is not necessarily true this ambiguous relationship with a simple that a foreign bank presence causes reduc- model in which they compare the impact tions in lending. As Cull and Martínez Pería of collateral and bank capital shocks under (2010) show, the context surrounding the a regime in which banks can allocate their entry of foreign banks is likely to affect the capital freely across states versus a regime relationship between their presence and credit with restricted interstate bank capital flows. levels. In this way, the negative relationship Although these shocks are contractionary in between foreign bank presence and credit lev- both environments, their magnitudes vary. If els could be driven by the nonrandom entry banks are allowed to move their capital freely, of foreign banks into banking markets that bank capital shocks in the host economy may were in crisis or had experienced large drops be less intense because international banks in credit levels prior to their entry. can import capital from abroad. However, 16. This pattern has been found especially in international banks may help amplify collat- developing countries, where foreign banks eral shocks in the host economy because they overwhelmingly lend to the safest, largest can lend away their capital. already-banked customers such as large firms, 9. A substantive share of the entry episodes of corporations, and public firms (Beck and foreign banks in emerging markets and devel- Brown 2013; Beck and Martínez Pería 2010; oping countries occurred after a financial cri- Berger, Klapper, and Udell 2001; Berger and 80 B R I C K - A N D - M O R TA R O P E R AT I O N S O F I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 others 2008; Bonin and Wachtel 2003; Gorm- they supervise a part of the banking group ley 2005; Mian 2003, 2006). that is not considered material to the global 17. Gennaioli, Martin, and Rossi (2014) provide bank) still have access to relevant information a theoretical model and empirical evidence about the bank using bilateral contacts. on how public defaults relate to the financial 25. Consider, for example, two Portuguese banks system and on how this relationship has a dis- operating in Mozambique that were autho- ciplinary effect on governments in countries rized to merge by Banco de Portugal in 2000. with good market institutions. Although this merger did not represent a 18. Similar trends are observed when comparing dramatic change in the financial sector of the returns on equity of both types of foreign Portugal, it significantly affected the banking banks. sector of Mozambique, where a new foreign 19. Although the phasing out of limits strongly banking entity with substantial market power encouraged foreign bank participation, it was was created. After the merger, almost 50 per- driven by compliance with the original WTO cent of banking assets in Mozambique were commitments. owned by this new institution. 20. The conclusions of this study are robust to 26. One example is Landsbanki, an Icelandic a series of tests that rule out that firms that bank that collected deposits from Dutch and borrow from local banks are statistically dif- British households through its online branch, ferent from firms that borrow from foreign Icesave. When the bank went bankrupt during banks. the global financial crisis, Icelandic deposit 21. Both the de jure and de facto dimensions of insurance should have applied to the Icelan- financial openness are examined. The de jure dic, Dutch, and British depositors of Icesave. dimensions are measured using Chinn and The Icelandic authorities, however, decided to Ito (2006, 2008), and Schindler (2009). The honor the insurance for only domestic deposi- de facto dimensions are (1) the sum of total tors, a decision that was later approved by a foreign assets and total foreign liabilities rela- European court (The Economist 2013b). The tive to GDP, (2) the sum of cross-border bank British government then used an antiterror- loans relative to GDP, and (3) FDI in banking. ism law to freeze the assets of the failed bank. 22. Evidence from Beck, Todorov, and Wagner Eventually, the losses of foreign depositors (2013) shows that during the global financial were covered by the British (fully) and Dutch crisis, the incentives of supervisors to resolve governments (up to €100,000)—see Zeissler, failing banks were distorted by the type of Piontek, and Metrick (2015). cross-border activities of these banks. 27. For example, in the United States the Volcker 23. Supervisory colleges are composed of the rule mandates the separation of proprietary supervisors of both the home and host coun- trading, hedge fund investments, and private tries of a foreign bank. Crisis management equity fund investments because they “gen- groups are integrated by the various home erate a risk culture that is fundamentally and host authorities of all global and large at odds with banks’ client-facing activities, systemic banks (such as central banks and particularly deposits, lending, and wholesale supervisory authorities) with the objective of banking” (Viñals and others 2013). increasing the ability to act quickly and effec- 28. Claessens (2016) discusses the various types tively in a crisis situation. of externalities and negative spillovers that 24 According to the Financial Stability Board these measures could create when coordina- (FSB 2015), it is important that host supervi- tion across countries is not in place. sors not represented in coordination groups 29. See Claeys and Hainz (2006) for a theoretical for different reasons (for example, because discussion. CHAPTER 3: KEY MESSAGES • Banks have globalized in part through their cross-border lending activity, which doubled from 2001 to 2014 and has become a substantial part of international capital transactions. The stock of cross-border bank claims around the world in 2012 was larger than that of cross- border portfolio holdings and foreign direct investment. • Whereas Japan, the United States, and Western Europe have historically accounted for most cross-border banking activity, economies in the “South” (mainly developing countries) have been gaining ground since the early 1990s. The South, as a source and destination of cross- border bank funds, increased from representing 28 percent of the world’s cross-border bank claims in 2001 to 33 percent in 2014, and from 21 percent of syndicated loans in 2001 to 31 percent in 2014. • Financial systems are multidimensional. Four characteristics are of particular interest • Theforgrowing participation benchmarking of the financial Southfiin systems: global nancial financial depth, transactions access, efficiency, has andallowed these stability. economies to not only diversify These characteristics need to their forbut investments be measured also obtain financial financing institutions and from abroad, com- markets. plementing domestic markets and widening their available funding choices. • Financial systems come in all shapes and sizes, and differ widely in terms of the four part of the risk-sharing • As characteristics. arrangement, As economies develop,cross-border banking services provided also by tends to financial act as atend transmis- markets to sion mechanism for external shocks. This tendency become more important than those provided by banks. was observed during the global financial crisis, when cross-border bank flows collapsed after having risen during the early 2000s. • The global financial crisis was not only about financial instability. In some economies, • Because the was the crisis largest global banks associated were mostly with important located changes in fiin high-income nancial countries access.hit by the depth and global financial crisis, the shock to their balance sheets affected both their domestic and cross- border activities, spilling over to developing countries. • Firms reacted to the decline in the supply of cross-border banking activity during the global financial crisis by switching to different sources of financing. In high-income and developing countries, firms moved toward bond markets. In developing countries, firms also switched to domestic banks. Because of these switches, global financial activity during the crisis declined to less than the collapse in cross-border loans. The change in debt composition then continued during the postcrisis period. The substitution and compositional effects were also observed at the aggregate level. Whereas before the global financial crisis, North–South lending grew faster than South–South lending, this situation reversed after the crisis. • The postcrisis period has also been characterized by the emergence of a broad set of technology- driven nonfinancial companies acting in parallel with traditional banking services. These so- called fintech companies have been adding solutions to different segments of the banking value chain, such as payments, cross-border transfers, and savings vehicles. Although the new players are ramping up competition and pushing digital transformation in the global financial sector, to date the level of disruption has seemed low, and their services appear highly comple- mentary to the ones provided by the more established banking sector. C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 3 Cross-Border Lending by International Banks ross-border bank credit has expanded and domestic loans, and also by the emer- C rapidly in recent decades, and has become an important part of global banks’ business activities. Cross-border bank gence of new digitally enabled businesses providing financial services outside the tra- ditional banking sector. These developments claims worldwide doubled during the period have allowed firms to diversify their funding 2001–14. An important part of this growth sources, but they also have exposed them to was transactions involving developing nations new types of risks. This chapter studies these as a source and destination of funds. For ex- developments, which have shaped the global ample, cross-border bank claims to develop- financial landscape in recent decades. ing economies expanded by a factor of three during the same period. The rise in cross- border bank credit to and from economies in THE PROS AND CONS OF the South occurred in parallel with the rapid CROSS-BORDER LENDING growth of other financial transactions, deep- Cross-border credit can provide both lend- ening developing countries’ integration into ers and borrowers with important benefits. global financial markets. Through cross-border banking, savings can This expansion has not been monotonic; cross-border lending has been characterized be channeled toward countries with more by boom-and-bust patterns. Of special im- productive investment opportunities, so that portance, because of its scope and length, was capital is allocated more efficiently globally. the across-the-board retrenchment observed It also allows global banks to achieve better during the global financial crisis. Although international risk diversification and to hedge cross-border lending to developing econo- against country-specific risks (De Haas and mies primarily originated with global banks van Lelyveld 2010; Goldberg 2009). From located in high-income countries, the period the borrowers’ perspective, global banks can since the crisis has been characterized by in- ease financial constraints in host economies creased South–South lending. Moreover, as by providing access to alternative sources of bank credit to and from high-income coun- external financing and compensating for the tries has declined, the postcrisis years have volatility of domestic credit (Allen and others been characterized by greater use of alterna- 2011). In turn, the presence of foreign capital tive sources of finance, such as bond markets may pressure policy makers in host countries GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 83 84 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 to adopt good policies and better governance banking. Capital flows are highly heteroge- practices so they can attract foreign lending neous across countries and regions, reflecting and to maintain those policies to avoid capital the relevance of a country’s idiosyncratic, or flight (Gourinchas and Jeanne 2009). Foreign pull, factors as drivers of capital flows. For capital also intensifies competition among the example, the literature has found macroeco- different providers of financing, thereby creat- nomic conditions in the recipient countries to ing a threat of “flight to quality” that can im- be important pull factors of cross-border flows prove the efficiency of the domestic banking (Buch, Carstensen, and Schertler 2009; Jean- system (Agenor 2003). neau and Micu 2002; Müller and Uhde 2013). And yet, cross-border banking can also Sound institutions are another important pose threats to financial stability through fi- driver. Using a large panel of financial flow nancial spillovers or contagion. An inevitable data from banks, Papaioannou (2009) finds consequence of international risk diversifica- that the protection of property rights, legal ef- tion is that global banks could cut foreign ficiency, and expropriation risk are important lending to accommodate adverse balance determinants of bank capital flows. Siregar sheet conditions at home, among other rea- and Choy (2010) find that political instabil- sons (Peek and Rosengren 2000). This is just ity and weaknesses in the legal, judicial, and part of the bargain; an economy open to in- bureaucratic systems help to explain the con- ternational transactions benefits from more tinued stagnation in lending after the Asian lending when times are good in the source financial crisis. Conversely, Kalemli-Ozcan, economy, and it receives less when times are Papaioannou, and Peydró (2010) show that bad. For example, some banks in Western in the European Union, the convergence in the Europe cut back credit to their Eastern Euro- legislative and regulatory frameworks with the pean subsidiaries during the global financial adoption of the euro has spurred cross-border crisis (Popov and Udell 2012). Global banks’ financial transactions. The literature also finds balance sheets were severely affected by the evidence of regulatory arbitrage. Cross-border crisis, and they reacted by pulling back from bank flows are positively correlated with regu- their international investments. Countries that latory restrictions in the source country and relied heavily on foreign lending during the negatively correlated with restrictions in the precrisis years were hit harder (Milesi-Ferretti recipient country (Aiyar, Calomiris, and Wie- and Tille 2011). Schnabl (2012) reveals how ladek 2014; Houston, Lin, and Ma 2012). the 1998 Russian default crisis was trans- Moreover, gravity models applied to interna- mitted to Peruvian banks by reduced cross- tional finance suggest that the geographical border lending to that country from global and cultural distances between countries are banks. According to Feyen and others (2014), also important factors explaining the volume credit growth in many countries is highly sen- of bank flows (Brüggemann, Kleinert, and sitive to cross-border banking shocks. Cross- Prieto 2011; Buch, Carstensen, and Schertler border bank flows are also more volatile than 2009; Heuchemer, Kleimeier, and Sander other types of cross-border flows (Levchenko 2009). and Mauro 2007) and local lending by foreign As financial globalization has increased, affiliates (Buch and Goldberg 2014; De Haas push factors have also become key drivers of and van Lelyveld 2004; García-Herrero and capital flows. Push factors refer to conditions Martínez Pería 2007; McCauley, McGuire, outside the recipient economy. These condi- and von Peter 2010; Peek and Rosengren tions can originate in one particular economy 2000; Schnabl 2012). or in several economies (involving a whole Country-specific pull factors—such as region or group of economies). Decades ago, macroeconomic conditions, sound institu- Calvo, Leiderman, and Reinhart (1993, 1996) tions, and the nature of the regulatory frame- pointed to global external factors as opposed work—are important drivers of cross-border to country-specific pull factors as the driving GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 85 forces behind cross-border flows. As the world of contagion during the global financial crisis has become more financially integrated, these and the sovereign debt crisis in Europe also global factors have gained importance over prompted some regulators around the world time, and cross-border flows have become to attempt to ring-fence their banking sys- more dependent on global financial and mon- tems (Cerutti and Schmieder 2014; D’Hulster etary policy circumstances, generally linked 2014; IMF 2015c). to conditions in core financial centers (Bruno The rest of this chapter focuses on three and Shin 2015a, 2015b). The term global li- important developments that are shaping the quidity, defined as ease of funding for global present and future of cross-border banking banks, has been used to determine how much and global banking more generally: the rise global banks are willing to lend abroad (Ce- of the South, the substitution across markets, torelli and Goldberg 2011; Herrmann and and the emergence of fintech. It begins by de- Mihaljek 2013; IMF 2014; Landau 2013; scribing the process of integrating the South Rey 2015). Empirical studies have commonly economies into global financial markets, with proxied global liquidity by bank leverage and particular emphasis on their participation in health conditions (Avdjiev, Kuti, and Takats cross-border bank flows. It then uses the ex- 2012; Bruno and Shin 2015a; Chui and oth- ample of the global financial crisis to illus- ers 2010; Düwel, Frey, and Lipponer 2011; trate how such a shock can be transmitted Hoggarth, Mahadeva, and Martin 2010; Mc- across borders and produce changes in the Guire and Tarashev 2008). Although most sources of finance at the global level, high- studies typically focus on funding conditions lighting some of the problems that arise when in the United States, Cerutti, Claessens, and countries become financially integrated. And Ratnovski (2016) find that cross-border bank it concludes by documenting how global flows are also driven by conditions in other banks are facing growing competition from financial centers, in particular the euro area new technology companies that are provid- and the United Kingdom. ing alternative types of financial services and As the role of push factors has intensified pushing transformation in the financial sys- over time, countries have become more vul- tem as a whole. nerable to foreign shocks, as witnessed during the global financial crisis. In fact, global fac- THE RISE OF THE SOUTH tors were the main reasons behind the decline in cross-border flows during the crisis, as op- Several papers and reports have discussed the posed to financial and economic conditions growing role of the South in the global bank- in recipient countries (Fratzscher 2012). In ing system.1 Typically, studies have looked particular, the shock to some U.S. banking in- at two different types of information: (1) the stitutions in 2008 was rapidly transmitted to asset and liability banking positions across the balance sheets of other global financial in- economies compiled by the Bank for Inter- stitutions, which reacted by deleveraging and national Settlements (BIS) and (2) the cross- retreating from their international activities. border flows of syndicated loans provided During the postcrisis years, global banks con- by private companies. For bank claims, this tinued to shrink from risk and reduce cross- chapter relies on BIS Locational Banking Sta- border activities as regulators imposed new tistics data used by Broner and others (2017). rules, such as Basel III, involving tighter capi- These data capture all reported gross cross- tal and liquidity requirements (the liquidity border positions between any two economies coverage ratio, LCR, and the net stable fund- transacted via the global banking system.2 ing ratio, NSFR), macroprudential policies, The syndicated loan flows data from Thom- and stricter stress tests, among others (Claes- son Reuters’s Securities Data Corporation sens 2016). The realization that cross-border (SDC) Platinum database consist of direct bank operations were an important channel cross-border lending through which a group 86 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 of financial intermediaries provides funds to a integration for the average developing econ- single borrower. Recent studies estimate that, omy over time (figure 3.1). In addition to the on average, syndicated loan exposures repre- unilateral reduction of formal restrictions on sented up to a third of the total cross-border international capital mobility (both on capital loan claims from 1995 to 2012 (Cerutti, inflows and outflows), developing economies Hale, and Minoiu 2015). However, these dif- have relied on other cooperative initiatives ferent data sets are not directly comparable in to boost their integration in global finan- terms of volume. Bank claims are stocks at a cial markets. Some examples of such initia- given point in time, whereas syndicated loans tives are the ASEAN Comprehensive Invest- data reflect flows based on transaction-level ment Agreement (ACIA), signed in 2009 by information.3 To offer a more complete pic- the Association of Southeast Asian Nations ture of the role of the South in the global fi- (ASEAN), the ASEAN Capital Market Fo- nancial system, this section provides evidence rum (ACMF), established in 2004; and the and discusses studies that use both types of more than 4,000 bilateral investment treaties data, which reveal two different but comple- signed by South economies between 1990 and mentary perspectives. 2013.4 These financial liberalization policies Since the 1990s, many developing econo- have promoted the integration of the South mies have undertaken significant efforts to into the global financial scene.5 liberalize and expand the scope and depth Partly as a result, South economies have of their financial systems. A wide range of become increasingly connected with the rest indicators shows better performance in de of the world in terms of cross-border bank jure measures of financial openness and lending. Cross-border bank claims and syndi- cated loans to and from the South expanded the most rapidly from 2002 to 2014 (com- FIGURE 3.1 Restrictions to Capital Flows: Average across Economies of the South, 1990–2013 pared with North–North lending).6 Indeed, South–South lending has grown faster than North–North, North–South, and South– 1 North lending. When considering cross- 0.9 border bank claims, South–South lending 0.8 grew from representing 5 percent of global 0.7 claims in 2001 to 9 percent in 2014. As Value of indicator 0.6 for syndicated loans, South–South lending grew from an average of 2 percent of total 0.5 world lending in 1996–2001 to 6 percent in 0.4 2002–14. However, these shares are still 0.3 small when compared with the volume of 0.2 North–North lending, which accounted 0.1 for 68 percent of world cross-border bank claims in 2014 and an average of 71 percent 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 of world syndicated loans in 2002–14 (figure 3.2). Alternative analyses that exclude China Chinn and Ito 2008 Quinn and Toyoda 2008 Fernández and others 2016 Kaminsky and Schmukler 2008 and the largest 20 economies in the South re- veal that these trends are not dominated by Sources: Chinn and Ito 2008; Fernández and others 2016; Kaminsky and Schmukler 2008; Quinn and these economies.7 As the South has gained Toyoda 2008. weight in terms of value (intensive margin), Note: This figure shows the average across economies of the South for several capital account and current account restriction indicators. All the indicators consider restrictions to both capital the number of its bilateral financial connec- inflows and outflows. The degree of restrictions is rescaled 0–1, where 0 means fully open and tions has also expanded (extensive margin). 1 means fully closed. The North comprises the G-7 economies and 15 other Western European economies. The South comprises the economies not included in the North. Offshore financial Connections involving South economies have centers are excluded from the sample. increased in all directions (North–South, GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 87 FIGURE 3.2 Direction of Cross-Border Bank Lending, Selected Years a. Cross-border bank claims 2001 2014 5.35% 8.46% 12.99% 10.37% 10.02% 71.65% 13.67% 67.50% b. Cross-border syndicated loan flows 1996–2001 2002–14 3.67% 2.07% 5.51% 6.31% 17.36% 17.06% 76.89% 71.13% North–North North–South South–North South–South Source: Broner and others 2017. Note: This figure shows the value of the stocks of cross-border bank claims scaled by worldwide cross-border bank claims and the value of flows of syndicated loans scaled by worldwide syndicated loans. Data are aggregated for all economies within a source region to all economies within a receiver region. For cross-border bank claims, end-of-the-year statistics are shown. For syndicated loans, the statistics are calculated year by year and then averaged over time. The North comprises the G-7 economies and 15 other Western European economies. The South comprises the economies not included in the North. Offshore financial centers are excluded from the sample. South–North, and South–South), but the new South.8 The remaining regions in the South South–South connections have expanded the are net capital importers, whereas the North fastest (map 3.1). stands as the major counterpart to these flows However, the South is not a homogeneous to the South and is thus a net creditor to the group; notable differences can be found across rest of the world (figure 3.3). Therefore, the regions in their inter- and intraregional lend- EAP region is not a typical South region, and ing patterns. Regarding interregional lend- its lending patterns are more similar to those ing, there is substantial heterogeneity in the of the North, which could be interpreted as net debtor-creditor positions with respect to a manifestation of the persistent current ac- the rest of the world. In particular, the East count surpluses run over the years by many Asia and Pacific (EAP) region stands out as economies in this region (Didier, Llovet, and the only net capital exporter region in the Schmukler 2017). 88 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 MAP 3.1 South–South Lending Connections a. Cross-border bank claims, 2001 b. Cross-border bank claims, 2014 c. Cross-border syndicated loan flows, 1996–2001 d. Cross-border syndicated loan flows, 2002–14 Source: Broner and others 2017. Note: The maps show only the connections between South economies. The lines in each map represent the active connections—that is, the country pairs for which the stock or the flow is positive. For syndicated loans, the lines in each map represent any connection that was positive during at least one year of the period analyzed. The North comprises the G-7 economies and 15 other Western European economies. The South comprises the economies not included in the North. Offshore financial centers are excluded from the sample. As for intraregional lending, EAP and the region’s financial centers of Hong Kong MENA are the most financially integrated SAR, China and Singapore. These three EAP regions in the South. On the one hand, economies accounted for 60 percent of EAP there are regions such as South Asia (SAR) intraregional syndicated lending in 2001–14. where intraregional syndicated loans only An extreme case of regional clustering is the accounted on average for less than 1 percent North, where intraregional syndicated loans of cross-border syndicated loans (intra- and captured about 76 percent of the North’s interregional loans) in 2001–14. On the total cross-border syndicated lending during other hand, in the EAP and MENA regions, the same period (figure 3.4). intraregional syndicated loans accounted on This period of increasing globalization average for 19 and 16 percent of cross-bor- was not monotonic—in fact, it came to a der loans, respectively. In the MENA region, sudden halt during the global financial crisis. intraregional syndicated loans were driven A general view is that the crisis put an end mainly by the economies in the Gulf Coop- to a trend of increasing financial globaliza- eration Council, which originated about 90 tion, leading to a fragmentation of the global percent of the total syndicated lending within banking sector (The Economist 2013a). the region in 2001–14 (Cortina, Ismail, and Economies reacted to the crisis by raising re- Schmukler 2016).9 In the EAP region, the strictions to capital mobility to reduce conta- largest intraregional lenders were China and gion (figure 3.1). Cross-border bank claims GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 89 FIGURE 3.3 Average Net Syndicated Loan Outflows by Region, 2001–14 174 100 80 Value, constant 2011 US$ (billions) 60 40 20 0 –20 –40 –60 –80 –100 East Asia Latin America Europe and Middle East South Asia Sub-Saharan North and Pacific and the Central Asia and Africa Caribbean North Africa Source: SDC Platinum. Note: This graph shows the average value of net syndicated loan outflows to the rest of the world for the period 2001–14. Net outflows are calculated as the difference between the value of the flows that a region sends to the rest of the world and the value of the flows that a region receives from the rest of the world. The data do not account for intraregional flows. The North comprises the G-7 economies and 15 other Western European economies. The South comprises the economies not included in the North. Offshore financial centers are excluded from the sample. declined from about $36 trillion in 2007 to FIGURE 3.4 Average Share of Intraregional Syndicated Loans of $32 trillion in 2009, leading to a change in Total Cross-Border Syndicated Loans, by Region, 2001–14 the nature of cross-border banking during the postcrisis period (Claessens 2016; IMF North 76 2015c). The reduction in the exposure of Sub-Saharan Africa banks in the North to some regions left a gap that has been filled in part by banks located South Asia in developing economies. Middle East and North Africa After the retrenchment in cross-border Europe and Central Asia banking activity during the global financial Latin America and the Caribbean crisis, cross-border lending changed its com- position; in particular, South–South transac- East Asia and Pacific tions grew the fastest, replacing the leading 0 2 4 6 8 10 12 14 16 18 20 role of North–South lending in the precrisis Percent years. The period before the crisis was char- acterized by fast growth in North–South Source: SDC Platinum. lending. During 2003–07 North–South bank Note: This figure shows the average share of intraregional cross-border syndicated loan flows in a region’s total cross-border syndicated loan flows for the period 2001–14. The North comprises the claims grew at an annual average rate of 19 G-7 economies and 15 other Western European economies. The South comprises the economies percent (33 percent for North–South syndi- not included in the North. Offshore financial centers are excluded from the sample. cated loans). However, the crisis led to a change in the global financial scene. After the retrenchment in bank credit during and South–South). Nevertheless, the fastest 2008–09, cross-border lending transactions increase took place in South–South lend- began to recover in almost all directions ing, which quickly overtook its precrisis (North–North, North–South, South–North, levels—see figures 3.5 and 3.6. Specifically, 90 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 South–South bank claims grew at an annual can be attributed to the expansion in the average rate of 11 percent (28 percent for value of both old and new connections.10 syndicated loans) between 2010 and 2014. As a consequence, South economies have These rates are much higher than those for increased their role as providers of funds to North–South lending, which grew at an an- other economies in the South since the global nual rate of 4 percent during the same period financial crisis. Although the North’s econo- (17 percent for syndicated loans). The faster mies are still the main lenders to developing growth of South–South credit after the crisis economies (the value of North–South lending FIGURE 3.5 Evolution of Cross-Border Bank Claims by Partner Economy, 2001–14 a. North–North b. North–South 35,000 5,000 4,500 30,000 4,000 Value, constant US$ (billions) Value, constant US$ (billions) 25,000 3,500 20,000 3,000 2,500 15,000 2,000 10,000 1,500 1,000 5,000 500 0 0 2001 2003 2005 2007 2009 2011 2013 2001 2003 2005 2007 2009 2011 2013 c. South–North d. South–South 4,500 3,000 4,000 2,500 3,500 Value, constant US$ (billions) Value, constant US$ (billions) 3,000 2,000 2,500 1,500 2,000 1,500 1,000 1,000 500 500 0 0 2001 2003 2005 2007 2009 2011 2013 2001 2003 2005 2007 2009 2011 2013 Old connections New connections Source: Broner and others 2017. Note: This figure shows the evolution of the value of cross-border bank claims over time by type of connection. Old connections are represented by the total value of country-pair links that were established in 2001, and new connections are represented by those that were established later. By definition, there were no new connections in the year 2001. The North comprises the G-7 economies and 15 other Western European economies. The South comprises the economies not included in the North. Offshore financial centers are excluded from the sample. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 91 is still larger than that of South–South lend- increased from 31 percent in 2009 to 38 per- ing), their participation in cross-border lend- cent in 2014. The same pattern is observed ing to the South has decreased over time, for syndicated loans, where the South’s shares giving way to economies in the South as grew from 26 percent in 2009 to 36 percent providers of funds (figure 3.7). This increas- in 2014. However, this trend has been domi- ing trend of the South accelerated after the nated by the EAP region, which accounts for crisis. The share of South economies in cross- the bulk of South–South transactions. The border bank credit channeled to the South participation of EAP as a lender of syndicated FIGURE 3.6 Evolution of Cross-Border Syndicated Loan Flows by Partner Economy, 1996–2014 a. North–North b. North–South 2,000 600 1,800 500 1,600 Value, constant US$ (billions) Value, constant US$ (billions) 1,400 400 1,200 1,000 300 800 200 600 400 100 200 0 0 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 c. South–North d. South–South 200 180 180 160 160 140 Value, constant US$ (billions) Value, constant US$ (billions) 140 120 120 100 100 80 80 60 60 40 40 20 20 0 0 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Old connections New connections Source: Broner and others 2017. Note: This figure shows the evolution of the value of syndicated loan flows over time by type of connection. Old connections are represented by the total value of country-pair links that were established during the period 1996–2001, and new connections are represented by those that were established later. By definition, these were no new connections in the years 1996–2001. The North comprises the G-7 economies and 15 other Western European economies. The South comprises the economies not included in the North. Offshore financial centers are excluded from the sample. 92 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FIGURE 3.7 Share of Lending to the South from the North and the South a. Cross-border bank claims, 2001–14 b. Cross-border syndicated loan flows, 1996–2014 100 100 90 90 80 80 70 70 60 60 50 50 Percent Percent 40 40 30 30 20 20 10 10 0 0 2001 2003 2005 2007 2009 2011 2013 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 North South Sources: Bank for International Settlements Locational Banking Statistics and SDC Platinum. Note: This figure shows the role of economies in the North and South as providers of funds to the South. The North comprises the G-7 economies and 15 other Western European economies. The South comprises the economies not included in the North. Offshore financial centers are excluded from the sample. loans to South economies after the global fi- percent, respectively, between the precrisis nancial crisis more than doubled its precrisis and postcrisis periods. level, originating on average 25 percent of The rise of the South in global banking is the total cross-border syndicated loans to the part of a broader trend involving different South during 2009–14, up from 12 percent types of cross-border financial transactions. during 2002–07. Broner and others (2017) document that An important part of the expansion in economies in the South have been gaining South–South bank credit since the global fi- market shares in global cross-border portfolio nancial crisis has been associated with a trend investments and foreign direct investment toward regionalization. Although both inter- (FDI) as well. During 2001–12, South–South and intraregional lending have played a role portfolio investments increased from $93 in the expansion of South–South syndicated billion to $1,067 billion, and FDI increased lending since the crisis, intraregional lending from $518 billion to $2,845 billion (box 3.1). has dominated this trend. In particular, in- The increasing presence of the South in traregional syndicated lending accounted on global financial transactions has been ac- average for 75 percent of South–South lend- companied by its growing influence in in- ing during 2010–14, up from 70 percent dur- ternational trade. Although the theoretical ing 2003–07. This pattern held across most literature is inconclusive about the relation- South regions, except for Latin America and ship between trade and capital flows, em- the Caribbean (LAC) and MENA. For ex- pirical studies seem to support the idea of ample, EAP’s intraregional syndicated lending complementarity between them. A number accounted for 78 percent of total EAP lend- of researchers have used gravity models to ing to the South during 2010–14, up from 71 document that country financial investments percent during 2003–07.11 The same applies are strongly biased toward trading partners to the Europe and Central Asia (ECA), Sub- (Aviat and Coeurdacier 2007; Dailami, Kur- Saharan Africa (SSA), and South Asia (SAR) lat, and Lim 2012; Daude and Fratzscher regions, where the share of intraregional syn- 2008; De Santis and Gerard 2009; Forbes dicated lending increased from 81 to 89 per- 2010; Lane and Milesi-Ferretti 2008; Portes cent, from 1 to 6 percent, and from 26 to 67 and Rey 2005). Among the channels relating GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 93 BOX 3.1 The Big Sur: Beyond Banking In a recent paper, Broner and others (2017) use that the South still expands faster than the North bilateral data on international investments to docu- in general, although at a more moderate rate when ment the importance of South economies in cross- investments are scaled by GDP. border portfolio investments, bank credit, and for- The authors report the growth of the South not eign direct investment (FDI). They show that the only in the value of cross-border financial invest- South has captured an increasingly sizable share ments but also in the number of fi nancial connec- of all types of financial transactions. Although tions (number of partners). More South economies the North still accounts for a signifi cant share of are becoming connected with each other and with international fi nancial activity, the South has been the North. growing faster than the North, in particular South– The patterns found in cross-border bank credit North and South–South investments. They also are comparable to those in portfolio holdings and fi nd that the expansion of the South, relative to the FDI. In particular, the authors report that the share North, accelerated in the aftermath of the global of South–South FDI in the world’s total FDI grew fi nancial crisis. from 8 percent in 2001 to 12 percent in 2012. More The authors argue that the faster expansion of impressive was the growth exhibited by South–South the South in cross-border fi nancial transactions is cross-border portfolio investments, whose share grew only partially explained by the faster growth of the from about 1 percent of total cross-border portfolio South’s gross domestic product (GDP). Results show holdings in 2001 to 3 percent in 2014 (figure B3.1.1). FIGURE B3.1.1 Direction of Foreign Direct Investment and Cross-Border Portfolio Investments, Selected Years a. FDI 2001 2012 3.34% 7.79% 5.68% 11.83% 17.14% 71.72% 22.37% 60.12% b. Cross-border portfolio investments 2001 2014 3.51% 0.94% 3.25% 5.57% 7.88% 13.20% 77.98% 87.67% North–North North–South South–North South–South Source: Broner and others 2017. Note: This figure shows the value of the stocks of cross-border investments scaled by total cross-border world investments for FDI and portfolio investments. Data are aggregated for all economies within a source region to all economies within a receiver region. End-of-the-year statistics are shown. The North comprises the G-7 economies and 15 other Western European economies. The South comprises the economies not included in the North. Offshore financial centers are excluded from the sample. (box continued next page) 94 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 3.1 The Big Sur: Beyond Banking (continued) Like South–South investments, North–South and when compared with those of North–North invest- South–North investments have presented an upward ments. As a benchmark, North–North investments sloping trend, although they have been growing at a accounted for 60 percent of global FDI in 2012, fall- slower pace. Nevertheless, developing economies do ing from 72 percent in 2001, and 78 percent of global not account for much of global financial transactions. cross-border portfolio investments in 2014, falling The South’s financial investment shares are still small from about 88 percent in 2001. cross-border trade and finance, there is the economies are becoming more connected in role of banks in reducing information asym- trade, one should expect a deepening of their metries between trading parties located in financial connections as well. Hanson (2012) different jurisdictions (box 3.2) and the use and Iapadre and Tajoli (2014) report how of trade as collateral to relax borrowing developing economies have been capturing constraints. Thus to the extent that South an increasing fraction of international trade BOX 3.2 Bank-Intermediated Trade Finance Banks facilitate international trade by generating enabled banks to automate payments and fi nancing trade credit, providing liquid working capital loans, across global supply chains for larger retail and and reducing risk in payment settlements for import- manufacturing companies (ICC 2016), as well as to ers and exporters. Bank-intermediated fi nance sup- distribute trade-related exposure through securitiza- ported between $6.5 and $8 trillion of international tion and loan sales to third-party, nonbank investors trade in 2011, or about one-third of the world aggre- (CGFS 2014). gate (CGFS 2014). Within this subset, $2 trillion was Among regions, there are important differences in intermediated by 21 large global banks participating the utilization of bank-intermediated trade finance. In in the International Chamber of Commerce (ICC) 2011 the Asia-Pacific economies, making up 36 per- Trade Register—a volume proportionate to their cent of global trade in the aggregate, received more combined asset sizes in the global banking indus- than half of bank trade financial flows, according to try. Nonbank trade fi nance mostly consists of inter- the Committee on the Global Financial System (CGFS fi rm credit supplied to factoring companies through 2014). By contrast, European economies, which are open account or cash-in-advance arrangements and more dependent on trade credit insurance, shared a receivable discounting. Within the class of financial quarter of global bank trade finance while generating institutions, banks provide the bulk of trade-related more than two-fi fths of global trade.a Bank-interme- fi nancial services; private insurance companies, for diated trade finance intensity is found to be higher for example, covered about $1.7 trillion, or 9 percent, of exports to countries that have lower levels of fi nan- global merchandise trade in 2011. cial development or weaker legal frameworks, or Banks finance importers and exporters and are farther away (Niepmann and Schmidt-Eisenlohr reduce their counterparty risks through a multitude 2013). However, as in any other type of cross-border of products, which primarily include letters of credit/ flow, trade fi nance can also be a channel of regula- guarantee, documentary collections, and loans in tory arbitrage in contexts with interest rate or foreign various forms. A letter of credit, for example, is exchange controls or with macroprudential policy issued by a bank on the buyer’s behalf as an obliga- differences (Reinhardt and Sowerbutts 2015). tion to pay the exporter upon satisfaction of speci- Historically, severe contractions in the supply of fied terms. More recently, industrial innovations have trade finance have amplified economic downturns (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 95 BOX 3.2 Bank-Intermediated Trade Finance (continued) FIGURE B3.2.1 Bank-Intermediated Trade Finance in Emerging and Advanced Economies: Quarterly Trends, 2005–13 a. Emerging economies b. Advanced economies 120 400 120 90 300 90 US$ (billions) US$ (billions) US$ (billions) 60 200 60 30 100 30 0 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2005 2006 2007 2008 2009 2010 2011 2012 2013 Brazil India Australia Spain France Hong Kong SAR, China China (right axis) Germany Italy United States Korea, Rep. Fund and Sources: International Monetary Fund; andnational nationaldata dataadapted adaptedfrom CGFS2014. fromCGFS 2014. 2008:Q2–2009:Q2. Note: The gray area indicates the global financial The series crisis forThe period. Italy includes series export for Italy and import includes guarantees, export and importwhich are off–balance which aresheet guarantees, items. sheet items. off–balance in emerging markets, notably during the 1997 Asian The postcrisis resilience of bank-intermediated financial crisis (IMF 2003). At the height of the trade finance could be attributed to three factors. global financial crisis in 2007–09, trade fi nance flows First, the general short span of credits and loans— declined sharply in the quarters following 2008:Q3, typically a window of 90–120 days during which rebounding quickly as trade regained its pace.b As merchandise receipt and settlement clearance can figure B3.2.1 illustrates, banks in China (including be processed—means that banks can adjust trade Hong Kong SAR, China), India, and the Repub- fi nance exposures relatively quickly, depending on lic of Korea led the recovery in emerging markets, their financial conditions.c Second, banks face an while in developed economies U.S. banks and their inherently lower default risk in trade finance con- global affi liates overtook the retrenchment of their tracts compared with that from other loan products German and Italian counterparts in the provision of because the merchandise is highly collateralized and trade fi nance. For the countries for which data are transported under standardized procedures. Third, available, statistical analysis indicates that the reduc- because of the risk levels in trade fi nance contracts, tion in the supply of trade fi nance accounted for up pricing conditions have generally been favorable for to 20 percent of the decrease in global trade during banks (CGFS 2014), although most recently this is the crisis. This effect was secondary compared with being eroded by profuse interbank liquidity, intensi- that from weakened real activities and reduced prices fying competition from new market participants, as (CGFS 2014), but nevertheless enormous economi- well as stricter regulatory compliance requirements cally in view of the $3.6 trillion decline in trade. (Starnes, Alexander, and Kurdyla 2016). a. The CGFS (2014) report is based on a combination of data sources, including International Monetary Fund, ICC Trade Registry, SWIFT, and national accounts. The regional share of bank-intermediated trade fi nance is estimated to be between 5 and 10 percent for the Middle East and North America, and about 5 percent for Africa and Latin America. b. Statistics tracking trade fi nance volumes in Australia, Brazil, France, Germany, Hong Kong SAR, China, India, Italy, Republic of Korea, Mexico, Spain, and the United States indicated a more than 50 percent decline, from a quarterly aggregate of $850 billion in 2008:Q3 to less than $400 billion in 2009:Q1. c. Less than 3 percent of bank trade fi nance exposure is medium to long term, according to Dealogic Loanware, a commercial data source. 96 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 over time and are changing global trading to save, and their governments were incapa- patterns. In particular, the South’s participa- ble of guaranteeing their survival (Buiter and tion (South–North and South–South transac- Sibert 2011).12 tions) in global exports rose from 27 percent Beyond the typical benefits of financial in 1990 to 53 percent in 2014. Although the integration, South–South banking may pro- growth of the South is apparent in North– mote the financial inclusion of previously un- South, South–North, and South–South direc- derserved segments. As with any cross-border tions, trade flows between developing econ- financial connection, greater South–South omies (South–South) are the ones that have connectivity may allow developing econo- increased the fastest. The participation of mies to benefit from financial diversification, South–South exports in total world exports more efficient resource allocation, access to a rose from 9 percent in 1990 to 31 percent in wider range of investment projects and fund- 2014. A similar expansion, though on a mi- ing sources, technology spillovers, and better nor scale, has been reported by North–South governance.13 It may also promote the de- exports (from 16 percent to 19 percent) and velopment of the domestic financial systems South–North exports (from 18 percent to 22 through increased competition.14 But the percent). In stark contrast with these trends, recent trends in South–South banking may the share of North–North exports fell by 50 also foster financial inclusion. Because banks percent during the same period. tend to be more familiar with the institutions, An important aspect of the rise of the language, and culture of economies located South in international finance and trade is as- within their region, most of South–South sociated with the fast growth of its gross do- credit occurs within regions. Consequently, mestic product (GDP). Since the early 1990s, banks in the South may tend to be better at economies in the South have been gaining collecting and managing information when space in the global economic landscape. In serving small and less informationally trans- fact, the GDP of the South, which was 24 parent segments, such as SMEs and house- percent of global GDP in 1990, almost dou- holds, relative to banks from the North. bled, to about 46 percent in 2014. However, Furthermore, increasing regionalization may South–South bank lending and financial in- facilitate cross-country regulatory and super- vestments still increased after accounting for visory coordination, as this tends to be easier the growth in the South’s real economic activ- to achieve at the regional level. ity, albeit at a slower pace. In fact, once GDP However, the latest developments in cross- growth is taken into account, South–South border banking may pose additional risks. bank claims and FDI are no longer growing Increasing regionalization in the South may faster than North–North and North–South limit risk-sharing, which would imply a larger transactions. exposure of a country to regional shocks and The multidimensional nature of the rise a faster spread of foreign shocks once they of the South in the global economy helps to hit one of the countries in the region. More- reduce concerns about a disproportionate over, South–South bank connections may growth of its banking system. In other words, generate financial instability stemming from the more prominent role of the South in the a laxer regulatory and supervisory environ- global banking system seems to be inevitable ment in the South relative to the North. In because of the South’s rapid expansion in real other words, to the extent that financial in- activity and its further diversified financial stitutions in the South are less tightly regu- sector, unlike in, for example, Iceland and Ire- lated than those in the North, the rise of the land. The banking systems of these countries South as a provider of cross-border lending grew too fast, and the authorities could not can negatively affect the stability of the over- respond with their own resources when the all financial system (Klomp and De Haan global financial crisis struck. By that time, Ice- 2014). In line with this argument, Claessens land’s and Ireland’s banks had become too big and van Horen (2016) and Mehigan (2016) GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 97 argue that the regulatory framework prevail- cross-border type. In particular, about 43 ing in the lender country is correlated with percent of the funds to high-income countries loan growth in the borrower country, finding and 86 percent to developing countries were that foreign banks from less regulated coun- originated overseas during 1991–2007. Banks tries could amplify credit booms in borrower in high-income countries were at the forefront countries. Because it is not possible for policy of not only the cross-border lending to other makers in the borrower countries to regulate high-income borrowers, but also most of the financial institutions in the lender countries, flows to developing countries. Western Euro- their policy agenda has moved toward the use pean banks alone intermediated about 53 per- of macroprudential policies to supervise and cent of the cross-border loans to developing manage cross-border credit. nations. The second-largest lender to devel- oping countries was the United States, which originated about 20 percent of cross-border SUBSTITUTION EFFECTS loans. DURING THE GLOBAL However, the global financial crisis hit FINANCIAL CRISIS global banks in the developed world espe- Global banks rapidly expanded their lend- cially hard, and these banks reacted by re- ing activities abroad before the global finan- ducing their lending activities worldwide. cial crisis, particularly during the 1990s and Specifically, the total volume of syndicated early 2000s. Between 1991 and 2007, the loans issued by firms in high-income coun- annual volume of syndicated loan issuances tries declined by about 62 percent from by nonfinancial corporations increased more 2007 to 2009 (figure 3.8). Developing coun- than seven times in high-income countries tries experienced a lower retrenchment in and more than eight times in developing ones loan financing, with a reduction of about 55 (figure 3.8).15 Following the general trend of percent during the same period. New loan increasing globalization, a significant part of financing declined relatively more in high- the loan flows over this period were of the income countries because the banking shock FIGURE 3.8 Total Amount Raised in Syndicated Loan Markets by High-Income and Developing Countries, 1991–2014 a. High-income countries b. Developing countries 4,000 100 400 100 90 90 3,500 350 80 Total loans, 2011 US$ (billions) Total loans, 2011 US$ (billions) 80 3,000 300 70 70 Share of total (%) Share of total (%) 2,500 250 60 60 2,000 50 200 50 40 40 1,500 150 30 30 1,000 100 20 20 500 10 50 10 0 0 0 0 19 1 92 94 96 98 00 02 04 06 08 10 12 14 19 1 92 94 96 98 00 02 04 06 08 10 12 14 9 9 19 19 19 19 20 20 20 20 20 20 20 20 19 19 19 19 20 20 20 20 20 20 20 20 Total syndicated loans (left axis) Cross-border syndicated loans (right axis) Source: SDC Platinum. Note: This figure displays the aggregate amount raised per year in syndicated loan markets by high-income (panel a) and developing (panel b) countries. It also shows (right axis) the share of the total volume lent in the form of cross-border loans. Only nonfinancial sector issues are included. 98 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 mainly affected financial institutions located Although the shock to global banking in in the global financial centers—the United high-income economies was largely transmit- States and Western Europe. As a result, ted to the developing world through the col- both domestic and cross-border bank flows lapse in cross-border lending, recent research declined in high-income countries, whereas suggests that a larger foreign bank presence only cross-border flows did so in develop- in borrowing countries can attenuate the ing countries. In fact, for cross-border loans transmission mechanism of these types of alone, developing countries showed a larger shocks (box 3.3). decline than high-income countries. Between Partially compensating for the cross-border 2007 and 2009, cross-border loans to high- collapse, the issuance of domestic loans in income countries declined by 64 percent, developing countries increased during the and to developing countries by 72 percent. crisis. The tightening of lending standards BOX 3.3 Foreign Banks and the International Transmission of Monetary Policy Since the fi nancial crisis, academics and policy mak- foreign bank ownership variable, which measures the ers have voiced concerns that monetary policies pur- fraction of borrower country banking assets that are sued by lending countries can have negative spillover foreign-owned. This fi nding implies that a reduction effects on the fi nancial stability of emerging markets in the lender country’s policy interest rate increases (Fischer 2014; Rajan 2014; Rey 2015). Consistent the volume of cross-border loans less if the foreign with this concern, recent studies have found evidence banking presence is greater. As shown in columns of the international transmission of monetary policy (2) and (3) of table B3.3.1, this result is robust to through its effect on the aggregate supply of cross- controlling for the borrower country’s level of eco- border loans. Using a VAR framework, Bruno and nomic development, as measured by its gross domes- Shin (2015a) show that a contractionary shock to tic product (GDP) per capita, and alternatively to the U.S. monetary policy leads to a decrease in cross-bor- borrower country’s level of fi nancial development, der bank lending. Studies using microdata on lend- as measured by its private credit provision relative to ing similarly fi nd evidence of the international trans- GDP. It is also robust to a range of borrower country mission of monetary policy to borrowing countries and lender country policy variables, including bank (see, for example, Morais and others, forthcoming). regulatory variables. Overall, the picture that emerges from these studies Foreign bank presence can affect the cross-border is that international banks are frequently sources of loan transmission channel of monetary policy through fi nancial instability because they transmit monetary a lender bank’s own experience and local presence in policy shocks to borrowing economies. the borrower country, or alternatively through the Demirgüç-Kunt, Horváth, and Huizinga (2017) role played by other foreign banks in the borrower provide evidence of the role of foreign banks in the country, by improving the quantity and quality of monetary transmission process that qualifies this pic- information available to potential new borrowers. ture. Using data on syndicated loans to 124 countries Demirgüç-Kunt, Horváth, and Huizinga (2017) find over the period 1995–2015, they fi nd that a greater evidence that the impact of a foreign bank presence foreign bank presence in a borrower country reduces on the transmission of lender country monetary policy the impact of changes in the lender country’s mon- through cross-border syndicated loans results not only etary policy interest rates on the provision of cross- from the lender bank having a subsidiary in the bor- border loans. Specifically, column (1) of table B3.3.1 rower country itself but also from other foreign banks shows that the volume of cross-border loans is related having subsidiaries in the borrower country. negatively to the policy interest rate, but positively The finding that the impact of lender country to an interaction of the policy interest rate with the interest rate changes on the cross-border loan supply (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 99 BOX 3.3 Foreign Banks and the International Transmission of Monetary Policy (continued) TABLE B3.3.1 Monetary Policy Interest Rates and the Cross-Border Syndicated Loan Volume (1) (2) (3) Variable Volume Volume Volume IR –1.781*** –2.930*** –2.276** (0.605) (0.716) (0.914) IR * foreign-owned banks (borrower) 0.0527*** 0.0563*** 0.0435** (0.0144) (0.0177) (0.0169) IR * GDP per capita (borrower) 0.0000450* (0.0000250) IR * private credit (borrower) 0.0112 (0.00869) QE –0.0729*** –0.0668*** –0.0743*** (0.0224) (0.0226) (0.0238) CPI 0.00671 0.00601 0.00476 (0.00449) (0.00407) (0.00401) GDP growth 0.00286* 0.00279* 0.00327** (0.00165) (0.00166) (0.00156) No. of observations 66,276 64,771 60,034 Adjusted R 2 0.803 0.802 0.801 Borrower*time FE Yes Yes Yes Lender FE Yes Yes Yes Source: Demirgüç-Kunt, Horváth, and Huizinga 2017. Note: The dependent variable is volume, which is the natural logarithm of the U.S. dollar amount of a bank’s share of a syndicated loan, aggregated at the borrower-lender-time level. IR is the central bank policy rate or the discount rate in the lender country; foreign-owned banks (borrower) is the fraction of the banking system’s assets in the borrower country that is foreign-owned (in percentage points); GDP per capita (borrower ) is the GDP per capita in the borrower country; private credit (borrower ) is the private credit relative to GDP in the borrower country; QE is a dummy variable indicating that a quantitative easing program is in place in the lender country; CPI is the annual percentage change in the consumer price index in the lender coun- try; GDP growth is the annual percentage change of real GDP in the lender country; FE = fixed effects. The sample includes nonfinancial borrowers. The sample period is from January 1995 to March 2015. Standard errors are clustered at the lender country and borrower country levels and are reported in parentheses. * = 10 percent, ** = 5 percent, *** = 1 percent. of international banks is reduced by foreign bank The evidence of a mitigating impact of foreign presence in the borrower country could well reflect bank presence on the transmission of monetary the fact that international banks can mix local and policy shocks through the international syndicated international funding for their loans. Consistent with loan market implies that international banks cannot this, Demirgüç-Kunt, Horváth, and Huizinga (2017) be characterized simply as sources of credit instabil- fi nd that the mitigating impact of foreign bank pres- ity in borrower countries that transmit international ence on the international transmission of monetary monetary policy changes in the form of international policy to the cross-border loan supply is weaker if the credit supply shocks. It also suggests that countries borrower country’s monetary policy interest rate is that restrict foreign bank presence could benefit from higher because it is likely to reduce the ability of an a more stable supply of cross-border credit by allow- international bank to substitute borrower country ing foreign bank entry. funding for lender country funding. 100 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FIGURE 3.9 Volume and Composition of Loan Issuance over Time, 2003–14 a. High-income countries Volume Composition 4,000 100 3,500 90 80 Volume, 2011 US$ (billions) Share of total loans (%) 3,000 70 2,500 60 2,000 50 1,500 40 30 1,000 20 500 10 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 b. Developing countries Volume Composition 400 100 350 90 80 Volume, 2011 US$ (billions) Share of total loans (%) 300 70 250 60 200 50 150 40 30 100 20 50 10 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Cross-border loans Domestic loans Total loans Source: SDC Platinum. Note: This figure displays the aggregate amount raised per year in domestic and cross-border syndicated loan markets by high-income and developing countries. and the difficulties in obtaining interna- 2009, which partially compensated for the tional bank finance were soon passed on to decline in cross-border inflows. However, it nonfinancial corporations, which, in some was mainly in Asian economies that domes- countries, seem to have reacted by changing tic lenders seem to have played a compensat- their debt market composition. For firms in ing role (table 3.1). developing countries, a first option was tap- Amid the global banking retrenchment ping domestic banks instead of the reced- during the global financial crisis, the volume ing international ones (figure 3.9). Indeed, of bond issuances experienced an increase the aggregate issuance of domestic loans worldwide. As the volume of cross-border increased by 44 percent between 2007 and loans collapsed during the crisis, bond markets GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 101 TABLE 3.1 Debt Issuance Change during the Global Financial Crisis Total debt Corporate bonds Syndicated loans Δ% Δ% Δ% Δ% Δ% cross- Δ% cross- Δ% corporate syndicated domestic border domestic border Region total debt bonds loans bonds bonds loans loans High-income countries –38 16 –52 7 31 –50 –54 Developing countries –22 56 –48 135 –38 33 –62 East Asia and Pacific 10 68 –12 89 0.4 10 –48 Europe and Central Asia –39 44 –55 43 45 –44 –59 Latin America and the Caribbean –34 20 –55 55 –39 –26 –56 Middle East and North Africa –61 –57 –62 59 –64 –44 –65 North America –46 20 –58 9 20 –62 –46 South Asia 26 26 33 158 –78 137 –68 Sub-Saharan Africa –51 –87 –37 –64 –90 –25 –39 Source: SDC Platinum. Note: Table shows the debt issuance change between the global financial crisis (2008–09) and 2007 (peak before the crisis). Each column shows changes within every single market. High-income countries are included in the subgroups according to their geographical location. The region classification is available at https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups. expanded (figure 3.10). In particular, bond volume) for the collapse of syndicated loans issuance increased by 48 percent in high- in high-income and developing countries. Im- income countries and by 106 percent in de- portantly, the use of corporate bonds rose in veloping countries between 2007 and 2009. most regions (table 3.1). In this sense, bond This expansion partially compensated (in markets fulfilled to some degree the “spare FIGURE 3.10 Composition of Debt Issuance over Time, 2003–14 b. Developing countries a. High-income countries 100 100 90 90 80 80 Share of total debt (%) Share of total debt (%) 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Corporate bonds Syndicated loans Source: SDC Platinum. Note: This figure displays the share of funds raised through corporate bond and syndicated loan markets over the total amount raised in debt markets by high-income (panel A) and developing countries (panel B). 102 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 tire” function advocated for capital markets of firm-level substitution at the global level (Greenspan 1999a, 1999b). However, only (beyond the United States) not only between very large corporations can access bond mar- bonds and loans but also between domestic kets (Didier, Levine, and Schmukler 2015), and international markets. and they do it largely through international The reported aggregate changes in debt issuances (Gozzi and others 2015). There- composition during the global financial cri- fore, it is not surprising that bond issuance sis took place at the country and firm levels activity increased even in those regions and (within firms). By using discrete logit models countries without sophisticated domestic cor- with country and firm fixed effects, Cortina, porate bond markets. Didier, and Schmukler (2016) analyze firms’ It is difficult to determine from the aggre- decisions to issue bonds versus syndicated gate data whether the changes in debt compo- loans in domestic and international markets sition during the global financial crisis were during crises versus normal times.17 The logit driven by within-firm market substitutions estimates indicate that the issuance of cor- or by a compositional change in the set of porate bonds relative to syndicated loans in- firms raising new debt. It is also challenging creased during the crisis within firms in both to determine whether such substitutions are high-income and developing countries. Con- caused by shifts in the supply of or demand ditional on debt issuance, during the crisis the for capital. For example, Kashyap, Stein, and probability of firms issuing bonds to obtain Wilcox (1993) study relative movements in new financing increased by 11.5 percentage bank loans and commercial paper to identify points in high-income countries and by 8.9 the bank lending channel of monetary trans- points in developing countries, for a 12 per- mission. But, as highlighted by Oliner and cent and 22 percent increase over the precrisis Rudebusch (1996), the heterogeneity of firms average, respectively.18 The estimates also in- in the aggregate data makes it difficult to dis- dicate the increasing use of domestic markets entangle supply from demand effects. Intend- relative to international markets during the ing to solve these issues, recent research has crisis, especially in developing countries. The analyzed whether firms in the United States probability of issuing domestic bonds (rela- substitute loans for bond financing during tive to international bonds) increased by 37 bank crunches, thereby providing evidence percent with respect to the precrisis average of the credit supply transmission channel in developing countries. Similarly, firms that (Adrian, Colla, and Shin 2013; Becker and raised funds in syndicated loan markets dur- Ivashina 2014). This research studies firm ing the crisis saw a fourfold increase in the decisions to issue bonds vis-à-vis loans when probability of doing so domestically (rather they are hit by a credit shock such as the than internationally). Because different mar- global financial crisis.16 Because issuing firms kets provide different types of debt financing, reveal a demand for financing, the focus is on these movements across markets provoked the market choice given this demand. For ex- by market-specific supply-side shocks directly ample, conditional on positive debt issuance, affect the nature of the new debt financing, a within-firm switch between syndicated such as the debt maturity structure of firms loans and bonds during a bank credit crisis and countries (box 3.4). is interpreted as evidence of a negative bank Although the overall level of lending ac- credit supply shock. Building on that type of tivity declined during the global financial methodology, Cortina, Didier, and Schmukler crisis, the substitution events seem to have (2016) study a wider and more heterogeneous mitigated (at least to some extent) the decline set of firms from all around the world. The in global banks’ lending. The drying up of global dimension of the data allows them bank credit during financial crises has nega- to analyze how firms react to domestic and tive effects on investment, employment, and external financial crises by moving across economic growth (Kroszner, Laeven, and markets. Therefore, they provide evidence Klingebiel 2007). However, if firms are able GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 103 BOX 3.4 Substitution Effects during Crises In a recent paper, Cortina, Didier, and Schmukler Third, the time-varying activity in each market (2016) use issuance data for four different debt mar- and the ensuing changes in debt composition are kets (domestic and international corporate bonds reflected in fi rm- and country-level maturities. Dur- and syndicated loans) to study (1) how fi rms use dif- ing the global fi nancial crisis, the maturity of debt ferent markets to borrow at different maturities, (2) at issuance declined in individual markets. How- how corporate- and country-level maturity depend ever, because the hardest-hit markets supplied rela- on which markets and which firms are active at each tively shorter-term maturities, firms’ movements point in time, and (3) whether fi rms switch across toward less affected markets had a positive impact different debt markets during market-specific crises. on the maturity of debt issuances. Consequently, the The main fi ndings of the authors are as follows. overall maturity at issuance remained stable both First, debt composition matters because different at the aggregate country level as well as for those markets provide fi nancing at different maturities. In fi rms able to move across markets. Firms issuing the particular, bond markets are, on average, of longer same type of debt before and in the aftermath of the maturity than syndicated loans. For high-income global fi nancial crisis experienced declining borrow- countries, domestic and international bonds are ing maturities in both high-income and developing significantly longer term than domestic and inter- countries. Similar patterns take place during domes- national syndicated loans. For developing countries, tic banking crises, when the overall debt maturity not only the instrument but also the market location increases, despite declines in the maturity of domes- is relevant. For example, the unconditional results tic syndicated loans. Thus these switches across mar- show that international syndicated loans are the kets provide evidence of supply side shocks with sig- shortest term, followed by domestic bonds, interna- nificant effects on debt maturity. tional bonds, and domestic syndicated loans. The Fourth, because larger firms have access to a maturity of debt issuances consistently varies across wider set of debt markets than smaller ones, the markets, even after controlling for time-varying, composition of fi rms also changes when shocks hit country-specific factors and fi rm-level fi xed effects, particular markets. For example, as the largest firms currency of issuance, and use of the proceeds raised. issued bonds and tapped into international markets, Thus the results indicate that part of the differences they were the ones capable of moving away from syn- in debt maturity across fi rms and countries lies in dicated loan markets during the global financial crisis differences across types of instrument and market and from local markets during domestic banking cri- location of the capital raised. ses. Furthermore, in developing countries, as larger Second, the relative importance of each market fi rms returned home during the global fi nancial cri- for fi rm fi nancing varies over time, with significant sis, they might have crowded out funding for smaller compositional effects, especially during market- fi rms that rely solely on domestic markets. In both specific crises. For example, when the global fi nancial cases, large fi rms gain relative to small ones, prompt- crisis suddenly hit the banking sector of major high- ing a compositional shift at the firm level with aggre- income countries, both domestic and international gate-level consequences. Overall, access to several syndicated loan markets were affected negatively and markets allows larger fi rms to use them as comple- fi rms moved toward issuing in domestic and inter- ments during good times, obtaining different types national bond markets. In developing countries, the of fi nancing in each, and as substitutes when condi- global financial crisis only affected international syn- tions deteriorate, cushioning the decline in volume in dicated loan markets, and fi rms reacted by moving certain markets and in maturity across all individual toward domestic markets, issuing both syndicated markets. The fi nancing conditions of smaller fi rms loans and bonds. An analogous pattern of switches are constrained by the specific market they access. occurs during domestic banking crises. Firms miti- In summary, the results from this report show gate the funding shock in the local banking system that although the demand side can be important for by moving away from domestic syndicated loans and maturity as firms choose their optimal financing, toward bond and international markets (table B3.4.1). the supply side (or type of market) is also relevant. (box continued next page) 104 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 3.4 Substitution Effects during Crises (continued) TABLE B3.4.1 Market Choice and Domestic Banking Crises Corporate bonds versus syndicated loans Domestic versus international loans Dependent variable: dummy (dit ) = 1 if Dependent variable: dummy (dit ) = 1 if the the firm issued a domestic loan in quarter firm issued a bond in quarter t ; dummy t ; dummy (dit ) = 0 if the firm issued an (dit ) = 0 if the firm issued a loan in quarter t international loan in quarter t Mean (dit ): 0.41 0.51 Country and year Firm fixed effects Country and year Firm fixed effects Fixed effects: dummies and year dummies dummies and year dummies Domestic banking crises 0.12*** 0.14*** –0.15*** –0.12*** [0.01] [0.01] [0.01] [0.02] No. of observations 110,436 47,354 63,571 19,012 No. of clusters 40,471 6,237 29,303 3,776 Source: Cortina, Didier, and Schmukler (2016). Note: Robust standard errors in brackets. *** p < 0.01, ** p < 0.05, * p < 0.1 In other words, the market of issuance matters for can issue. By using issuance data across markets, the the maturity structure of fi rms and countries, even authors provide evidence that fi rms constrained to after controlling for factors that the literature high- one market face a different maturity structure than lights as key determinants of the maturity choice. To fi rms that obtain fi nancing in a different market or the extent that markets specialize in particular types fi rms that tap multiple markets. Therefore, by ana- of fi nancing, fi rms might decide to issue in specific lyzing a wider set of debt markets, the authors reveal markets to obtain fi nancing at different maturities. a broader perspective on how firm and country When firms cannot choose markets, they will be fi nancing as well as maturity behave. constrained by the financing available where they to substitute bond financing for bank financ- the global financial crisis, the access to alter- ing, the negative effects on investments and native sources of external finance by firms growth would be reduced (Greenspan 1999a, would have mitigated to some extent the ad- 1999b). Recent theoretical models show that verse effects of the crisis on the performance flexibility in the financial system through ac- of firms and countries. Although empirical as- cess to alternative debt markets helps to cush- sessments of this type of argument are scarce, ion the negative real effects (on investment Levine, Lin, and Xie (2016) show that coun- and output) of adverse shocks to the bank- tries in which firms have easier access to stock ing system (Crouzet 2016; De Fiore and Uhlig markets experience smaller deteriorations in 2015)—not completely, however, because corporate investment following banking cri- bond markets and bank credit are not perfect ses. Nevertheless, it is also important to con- substitutes (Crouzet 2016). In the context of sider the compositional change in the types GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 105 of issuers that are tapping each market over financial crisis continued during the postcrisis time. For example, during domestic crises, years. Regulatory reforms aimed at avoiding only relatively larger firms will have access to systemic risks (higher capital and liquidity re- alternative markets (bonds and international quirements), combined with the higher com- loans). During foreign shocks, large interna- pliance costs to combat money laundering tional firms switching to domestic markets and the financing of terrorism and to increase can potentially crowd small domestic issu- transparency, led to a de-risking of global ers out of the market (Cortina, Didier, and banks from their relatively riskier cross- Schmukler 2016). border activities and a withdrawal from cor- The shift in the pattern of global financial respondent banking relationships (box 3.5). intermediation that began during the global As such, cross-border lending as a share of BOX 3.5 De-risking in Correspondent Banking Correspondent banking, in the context of global Although profitability and risk appetite are critical fi nance, refers to the services provided by a bank (the factors in banks’ commercial decisions, the retrench- correspondent) to another fi nancial institution (the ment from correspondent relationships has occurred respondent) and its clients by extension. Large inter- against a backdrop of more stringent enforcement of national banks typically serve as correspondents to the anti–money laundering and combating fi nancing settle payments and clear foreign currency transac- of terrorism (AML-CFT) rules (World Bank 2015a). tions for local and regional banks that in turn sup- Because of the ambiguity in regulatory expecta- port money transfer operators and other businesses. tions and the unquantifiable potential for reputa- Correspondent banking connects local economies tional impact, many correspondents have chosen to which would otherwise have limited access to the de-risk by restricting or exiting relationships with international fi nancial system, and underpins trade institutions that are deemed excessively risky (see fi nance, remittances, and humanitarian flows. panel a, figure B3.5.1). Wholesale de-risking at the Global banks’ recent retrenchment from corre- jurisdiction or sector level, independent of the type spondent relationships has garnered attention from of customer, reflects a shift away from case-by-case multiple international institutions for its potential risk management to risk avoidance (FATF 2014). downside impact on fi nancial stability and economic Humanitarian aid beneficiaries (World Bank 2016b), development. A joint World Bank-FSB-CPMI survey small exporters (Starnes, Alexander, and Kurdyla found that about half of national banking regula- 2016), and nonbank international remittance com- tors, three-fifths of local and regional banks, and panies (Ramachandran 2016; World Bank 2015b) three-quarters of large international banks indicated served by local and regional banks are among the declines in correspondent banking (World Bank most vulnerable to general de-risking (see panel b, 2015a). The retrenchment originated in banks in figure B3.5.1 for example). Canada, Switzerland, the United States, the United Early evidence points to the need for further Kingdom, and other EU economies. It has affected research to determine developmental impacts. For institutions in the Latin America and the Caribbean, example, analyzing SWIFT bank payment informa- Middle East and North Africa, Sub-Saharan Africa, tion, the CPMI (2016) found that the number of cor- and Europe and Central Asia regions, particularly respondent relationships had fallen during 2011–15, those located in offshore centers and jurisdictions at a whereas the volume and value of transactions indi- high risk of illicit financing.a As pointed out by a new cated that those relationships had increased (panel a, IFC survey, the pervasiveness of withdrawal has chal- figure B3.5.1). This fi nding reveals the growing con- lenged the ability of respondent banks to serve clients centration and complexity in correspondent banking, and further develop banking business needed for eco- consistent with the World Bank-FSB-CPMI survey nomic diversification (Starnes and others 2017). finding that local and regional banks have gener- (box continued next page) 106 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 3.5 De-risking in Correspondent Banking (continued) FIGURE B3.5.1 Correspondent Banking: Recent Developments a. Trends in correspondent payments, 2010–15 b. Correspondent banking and remittance costs, 2012–15 130 6 Change in cost margin of remittances 125 4 120 2 (percentage points) 115 0 Index 110 –2 105 –4 100 –6 95 –8 90 –10 2010 2011 2012 2013 2014 2015 –50 –40 –30 –20 –10 0 10 20 Active correspondents Transactions Value Number of active correspondents, percentage change Sources: Deutsche Bank and SWIFT Watch, adapted from CPMI (2016) and World Development Indicators (database). Note: In panel a, the series are indexed as 100 times the current values divided by those of January 2011. ally been successful in fi nding replacement institu- supervisory perspective, it is becoming increasingly tions or alternative financing channels. Often, this is challenging to monitor and enforce the financial achieved through nested correspondent relationships integrity of layered arrangements because of their at the cost of excluding part of the respondent cus- complexity and opacity (Ramachandran 2016). Last tomer base, as required by correspondence providers but not the least, nested relationships are signifi- (World Bank 2015a). cantly costlier to establish and service when there is Following the large global banks’ withdrawal, limited coordination in regulatory standards across this condensation through additional layers of finan- countries (World Bank 2015b). Hence, a widespread cial intermediation carries several risks. In terms of uncontained retrenchment from correspondent bank- business control, the smaller Tier 2 and 3 correspon- ing can threaten progress toward fi nancial stability dent banks are often less well positioned to piece and inclusive growth, and these trends need to be together fi nancial intelligence from complex client followed closely. For a rigorous analysis to support relationships and process large-volume transactions the decline in correspondent banking, however, bet- in a timely fashion (World Bank 2015a). From a ter data going beyond anecdotal evidence are needed. a. The withdrawal of correspondent banking can affect local fi nancial systems significantly. For example, the nonofficial fi nancial sector in Angola lost access to U.S. dollar clearing in December 2015. Access to U.S. dollar payments was merely sustained through the Banco Nacional de Angola. Monetary authorities have also experienced terminations of correspondent relationships, such as in Belize (IMF 2016). total banking assets declined, driven largely issued was 18 percent on average during the by the retrenchment of European banks (IMF precrisis years and 50 percent during the 2015c). Moreover, the higher propensity of postcrisis ones. Bond finance also continued developing countries to issue domestic loans to gain importance during the years follow- continued during 2010–14. The share of ing the crisis. The share of bonds of total domestic loans in the total volume of loans debt rose from 33 percent to 42 percent in GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 107 high-income countries and from 42 percent to financial conditions for domestic liquidity and 57 percent in developing countries when com- credit growth. As the reliance on international paring pre- and postcrisis years. bond markets continues to rise with respect to The change in debt market composition cross-border banking, the locus of risks shifts during and after the global financial crisis re- from banks to nonbank institutions, which duced the exposure of borrowing firms and may complicate surveillance of the global countries to global banking conditions, but it financial system (IMF 2015c). Moreover, al- increased their exposure to international bond though the increasing use of domestic loan markets. The expansion of corporate borrow- markets in developing countries reduces their ing in bond markets (and away from banks) exposure to global financial shocks, it may since the crisis has been labeled the “second increase their vulnerability to domestic and phase of global liquidity” (Shin 2013). Unlike regional banking crises. in the first phase, in which global banks mo- The patterns highlighted in this section nopolized global liquidity, international bond imply that policy discussions would benefit markets are taking the lead during the second from considering other key components of phase. Thus, international bond markets have the global financial system, beyond the single taken on a larger role in the transmission of focus on cross-border banking. Because there financial conditions across borders since the are different markets where corporates obtain crisis. Because a large part of the bond issu- new debt financing, it is important to jointly ances has been denominated in U.S. dollars, analyze the dynamics across those markets. For developing countries have become more ex- example, firms can better withstand market- posed to movements in U.S. interest rates and specific adverse shocks through their access exchange rates (McCauley, McGuire, and Su- to alternative sources of external finance. shko 2015; Shin 2013). Holding large liabili- Although this section focuses on the role of ties in foreign currency while having assets in capital markets as complements of bank fi- local currency can be risky, as demonstrated nancing during crisis periods, this argument during the crises in Mexico and Asia in the can also be generalized to “good” times and 1990s.19 But this time, the provision of longer- can be a topic for future research. In this way, term issuances by bond markets (relative to access to more complete markets may allow bank credit) may be mitigating to some ex- firms and countries to diversify their financing tent the risk of capital flow reversals and for- sources and reduce the risks associated with eign currency financing (Cortina, Didier, and financial contagion. However, global financial Schmukler 2016). This new trend can also markets are not perfectly integrated, and sev- affect domestic credit through the so-called eral frictions result in different markets pro- carry trade (Bruno and Shin 2017). In this viding different types of financing, even for sense, low interest rates in high-income coun- the same firm (such as in terms of maturity or tries would fuel nonfinancial corporations currency denomination). As a result, changes in developing countries to issue foreign cur- in debt market composition over time also ex- rency bonds and use the proceeds not solely pose firms and countries to new types of risks. to support real investment but also to serve as Moreover, despite the fact that debt is the savings in the form of cash holdings or other main source of external financing for invest- liquid assets, thereby increasing the domestic ment projects, most of the theoretical models credit capacity (Acharya and others 2015; of debt market frictions are constrained to a Acharya and Vij 2016; IMF 2015b). For ex- single type of debt, typically bank debt. Al- ample, Powell (2014) documents a positive though this finding might be true for small correlation between bond issuances by Latin firms, it does not hold for relatively large cor- American corporations, corporate deposits porations, which typically have a broader ac- in LAC financial institutions, and domestic cess to alternative sources of external finance. credit. In this way, nonfinancial institutions In this sense, policy initiatives, such as the become important conduits of international Capital Markets Union in Europe (European 108 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Commission 2015), the development of capi- scant, according to some estimates at least tal markets for SMEs, as well as those initia- 4,000 fintech firms were active in 2015, and tives aimed at developing innovative instru- over a dozen of them were valued at over ments, such as minibonds, and securitization $1 billion (The Economist 2015). Meanwhile, may be important tools to broaden external this trend is growing very quickly. The global funding choices for a wider set of firms (Bo- investment in fintech was about $22.3 billion rensztein and others 2008; Giovannini and in 2015, or more than 12 times the invest- others 2015). ment amount in 2010 (Accenture 2016). The United States and the United Kingdom ap- pear to be the world leaders in fintech invest- FINTECH AND THE FUTURE OF ments, although these firms operate globally, GLOBAL BANKING providing services to developing economies This section provides an overview of some of as well. Fintech firms in the United States at- the latest fintech developments and how they tracted most of the investments between 2010 are related to global banking. In particular, and 2015—about 63 percent of the total. it describes how fintech might provide alter- The United Kingdom is the second-largest native sources of external financing, increase attractor of investments, absorbing 11 per- competition, push innovation, and introduce cent of the total, but Nordic economies such new technologies that can potentially dis- as Sweden are also becoming leading fintech intermediate many financial processes such centers globally.20 In terms of growth, Asia as cross-border payments. Consumers and has experienced the fastest expansion of fin- small and medium-sized enterprises (SMEs) tech in recent years. Investment in Asian fin- are the segments most affected by innovative tech companies accounted for 19 percent of fintech solutions. the world’s total fintech investment in 2015, Although there is no consensus on what up from 6 percent in 2010. China captured “fintech” means, and it is typically used to de- most of that growth by absorbing about 45 scribe disruptive technologies in the financial percent of the total investment in that region system, this section uses the term in conjunc- by 2015 (box 3.6). The role of India was im- tion with the set of tech-driven new compa- portant as well; it accounted for 38 percent of nies providing financial services outside the total Asian investment for the same year (Ac- traditional financial sector. The retrenchment centure 2016). Most of fintech funding has and intensified regulation of the traditional been directed at the personal and SME space banking system after the global financial cri- (lending, payments, and transfers), which has sis, combined with the greater access to in- absorbed over 70 percent of the total fintech formation technology and the wider use of investments to date (Citigroup 2016). Other mobile devices, have given a new generation fintech areas such as wealth management of firms outside the traditional banking sec- and insurance, although smaller in size, have tor an opportunity to innovate and deliver recently been attracting a large share of the financial services. These new players, which global investments (Accenture 2016). are still very young (most emerged after the In lending, the emerging online platforms crisis), are bringing new business models and are alternative forms of intermediating credit innovations to multiple segments of the fi- beyond the traditional credit system. Most of nancial world, including lending, payments the alternative lending platforms emerged us- and transfers, and wealth management. This ing the so-called peer-to-peer (or P2P) model section covers only the first two segments in the aftermath of the global financial cri- because they are the areas that most signifi- sis, when the availability of traditional bank cantly affect the traditional banking industry. credit was quite limited.21 This type of lend- Global investment in fintech companies ing model allows direct lending from savers has expanded very rapidly worldwide. Al- to borrowers, avoiding the traditional sys- though available data on fintech are very tem of financial intermediation. However, GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 109 BOX 3.6 Fintech in China: An Overview The fi ntech sector has seen extraordinary growth in in China as of 2016:Q2 was processed by nonbank China in recent years. Despite the general scarcity institutions, as opposed to traditional payment ser- of offi cial statistics on fi ntech development, China vice providers (Saal, Starnes, and Rehermann 2017). appears to be one of the global leaders in fintech Thanks to their cost-efficiency, reliability, and ease of innovation and adoption. Fintech in China attracted use, digital payments have enabled large parts of the $8.8 billion during 2015:Q3–16:Q2 in terms of vol- cash-based Chinese economy to leapfrog over credit ume of investment, representing 352 percent of the card systems, absorbing fees paid to traditional pay- volume in 2010 (Mittal and Lloyd 2016). In 2016, 30 ment intermediaries in the process. percent of the fi ntech fi rms valued at more than $1 Flourishing within a similar environment, the fi n- billion were located in China (panel a, figure B3.6.1). tech lending sector exploited the fi nancial needs of In terms of adoption and usage, credit provided by households and small and medium-sized enterprises the peer-to-peer (P2P) subsector increased from $4.3 (SMEs) that were not met by traditional service billion in 2013 to $71.4 billion in 2015 (PIIE 2016), providers.b P2P platforms have rapidly seized oppor- and the volume of mobile payments reached $4.4 tril- tunities not taken by traditional intermediaries, lion in 2015, accounting for 40 percent of China’s designing competitive products in search of custom- gross domestic product (GDP)—see PBOC (2016). ers and profits under broadly accommodative regula- Payment platforms—which largely derive their tory conditions. user base from thriving e-commerce and social Although P2P lending can improve efficiency and media platforms—by far dominate the fi ntech space promote access to underserved segments of SMEs in China (panel b, figure B3.6.1). Service providers and retail customers, the many platforms operating have been able to leverage the large economies of in China have not been a riskless solution to mitigat- scale thanks to the high level of smartphone penetra- ing the banking industry’s primary focus on state- tion. For example, Ant Financial (formerly Alipay), owned enterprises and well-known borrowers. As the largest payment service provider, supported 451 consolidation among more than 2,000 platforms million active users in 2015 and processed on aver- accelerated in 2015, a more pronounced regulatory age 153 million transactions a day (Alibaba Group approach to credit limits was adopted to improve sec- 2016).a Notably, 54 percent of the payment volume toral soundness. By August 2016, several prominent FIGURE B3.6.1 Fintech “Unicorns”: Fintech Firms with a Valuation of over $1 Billion, 2016 a. Number of firms b. Valuation by sector China 5 United States 14 8 Rest of world 0 20 40 60 80 100 Sector value, US$ (billions) Payments Insurance United States China Rest of world Lending/financing Other services Source: Adapted from Visual Capitalist 2016. (box continued next page) 110 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 BOX 3.6 Fintech in China: An Overview (continued) exits had triggered further regulation of loan size and Building on domestic experience, large Chinese custodian requirements for investor funds (CBRC technology companies are venturing into developing 2016b), aiming to address concerns about potential countries such as India, Thailand, the Russian Fed- systemic risk. eration, and Brazil through brownfield investments Under an innovative approach to promoting and collaborative efforts (Mittal and Lloyd 2016). SME capital access and facilitating fi nancial sector However, the fi ntech sector is facing challenges as reforms, Chinese regulatory authorities are allowing markets, regulations, and perceptions continue to several large technology companies to venture into evolve. Incumbent intermediaries are innovating to lending services directly. Precluded from brick-and- bridge gaps in financial access, while retail investors mortar operations under special banking licenses, are becoming more informed about the risks and this class of online intermediaries collects deposits, returns of fi ntech products. Because cyber security, assesses creditworthiness via cloud-based and data- AML-CFT (anti–money laundering and combating driven analytics (using, for example, the borrowers’ fi nancing of terrorism), and prudential compliance marketplace and social network records), and lends all remain valid concerns within the current regula- using streamlined processes. Being one step closer to tory approach to the fi ntech sandbox, it helps when the technology sector’s vision of integrated fi nancial both the industry and the regulator are vigilant and services, these intermediaries are able to draw on the proactive about risks in order to maintain an envi- accumulated expertise of fi nance as an ecology, pos- ronment conducive to healthy developments in this sibly leading to further innovations. promising sector. a. The comparable value for Visa is 260 million transactions a day globally; and for MasterCard, 180 million. b. Total assets in the Chinese banking system constituted 290 percent of GDP by the end of 2015, according to calculations based on the China Banking Regulatory Commission’s annual report (CBRC 2016a). Credit to households as of 2015 was 39 percent of GDP (BIS Credit to the Non-fi nancial Sector database, 2016). Furthermore, despite contributing to about four-fi fths of urban employment and three-fi fths of national GDP, SMEs as a sector receive less than a quarter of bank loans, in part because of their lack of collateral and fi nancial track records (Mittal and Lloyd 2016). the industry has evolved, and the term peer- data mining to assess credit risk, accelerate to-peer has become somewhat inaccurate. lending processes, and lower operating costs. Most of the loans include funding from a The new digital lending sector is attracting wide range of investors (including financial a massive number of entrants. According to institutions and institutional investors). Thus Autonomous (2016), in 2006 only two econ- P2P lending can be considered a form of on- omies were home to digital lenders. By 2016, line crowdfunding, a term that includes other 67 economies had digital lenders, and over types of platforms where multiple individuals 2,000 players were thought to be operating pool their contributions in a larger fund (Atz worldwide (over 200 in the United States). and Bholat 2016). Online lending platforms In payments and transfers, innovative solu- have no retail branches and typically provide tions are rapidly changing the way consumers faster loan applications and smaller shorter- engage in financial transactions. Indeed, the term loans than traditional credit institutions. payment industry had largely evolved before These new platforms also involve alterna- the latest fintech expansion. For example, tive credit models that help lenders to assess with the adoption of credit cards in the 1950s the credit risk of a broader set of borrowers. and the rise of e-commerce during the 1990s, They replace traditional credit scoring with cash and checks were no longer the main machine learning and algorithms based on big means of transaction in many high-income GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 111 economies (World Economic Forum 2016b).22 recorded on a distributed platform—that is, Another likely consequence of the expansion the database is not stored in a single location in e-commerce is that the consumer and re- but distributed among millions of computers, tail payments segment has been the fastest- which replace the traditional trusted interme- growing area in terms of innovative solutions diaries by keeping track of old transactions and fintech new entrants (BNY Mellon 2015). and verifying new ones (figure 3.11). Block- In payments, the most recent innovations have chain technology records the transaction his- focused on the user experience, leveraging mo- tory better than any other electronic money bile devices, and connectivity (front-end pro- or means of payment (Schuh and Shy 2016). cesses), but the existing payment infrastruc- Thus this technology upends one of the most ture remains mostly the same. An example is important tasks of the traditional financial in- the use of mobile phones to make payments dustry, which is to act as a trusted intermedi- at a physical location (for example, Apple ary for transactions between separated (some- Pay, Samsung Pay). As for transfers, the cur- times unknown) entities. In the same way the rent system is built on several intermediaries, Internet has revolutionized the diffusion of such as automated clearinghouses and inter- information, blockchain technology is revolu- mediary banks (corresponding banks), which tionizing the way in which parties send funds make the process of value transfer sometimes (see, for example, Forbes 2016). costly and slow. Innovations in this area make The potential of blockchain technol- transactions between individuals (and some- ogy goes beyond its uses as a digital form of times across economies) easier, faster, and cash because it can be applied to many other cheaper than in the past. For example, mobile transfer processes, including global bank pay- money solutions such as M-Pesa make pos- ments. Blockchain technology provides a new sible peer-to-peer transactions through the use payment infrastructure, so it can disinterme- of mobile devices without the need for a bank diate many financial (and nonfinancial) pro- account. And new business models such as cesses (“blockchain 2.0”), thereby increasing TransferWise and Azimo allow customers to speed and efficiency and lowering transac- send money across borders by matching trans- tion costs. Several global banks and financial actions with other users trying to send flows institutions are already collaborating with in the opposite direction, thereby avoiding the technology companies to further experiment high fees associated with international trans- with blockchain. For example, Ripple and fers because the money never really leaves the R3 are trying to create their own blockchain economy of origin. Perhaps the most impor- network for global banks, avoiding clearing- tant and disruptive types of innovations are houses and correspondent banks. The Tokyo those based on new technologies, most promi- Stock Exchange, in the collaboration with nently the blockchain. IBM, is testing systems to record trades for Blockchain is a decentralized payment low-transaction markets using blockchain scheme that does not require a single trusted (Adriano and Monroe 2016). The U.S. Nas- third party to validate transactions. As the daq stock exchange was the first one to incor- technology behind the bitcoin, the best- porate blockchain services (CoinDesk 2016). known cryptocurrency, blockchain has the Other applications of blockchain are to reg- potential to disintermediate any type of finan- istries and transactions of other digital assets cial transaction.23 The total market value of (such as blockchain-based property registries) all bitcoins in circulation by September 2017 and smart contracts, which are self-executing was over $60 billion.24 Blockchain is a sys- contracts without the third-party interference tem of online exchange that uses powerful and without input by lawyers or recourse to encryption to allow peer-to-peer transactions the courts (for example, Ethereum). More ef- of digital assets without the need for a trusted ficient arrangement and management of syn- third party, such as a bank, to clear and settle dicated loan contracts could result from the payments. It consists of a log of transactions application of smart contracts, and that is one 112 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 FIGURE 3.11 How Blockchain Works A A The transaction is broadcast to the network The transaction, along with others, is 1 A requests a digital transaction to B 2 3 of “miners” packaged and recorded as a block B The new block of confirmed transactions The transaction from A to B is verified The network of miners validates the block of 5 6 4 is added to the existing blockchain and completed transactions Sources: Illustration by the GFDR team. application that directly affects global banking Therefore, in many economies, remittances activities (World Economic Forum 2016b). are a pathway to economic development All recent innovations and business mod- and financial inclusion. However, the exist- els arising from the latest fintech develop- ing cross-border payment banking system is ments could also affect remittances. Remit- slow (it takes days to settle), and the average tances constitute one of the biggest flows of cost of transactions is high. New digital inno- funds from the developed to the developing vations and the broader use of smartphones world (excluding China)—larger than offi- and mobile wallets are key to reducing costs cial development aid, FDI flows, and corpo- and speeding up international transactions. rate investment (private debt and portfolio Again, blockchain technology could be es- equity flows). According to the World Bank pecially useful. An example is Rebbit in the (2016a), the global flow of remittances was Philippines, which builds on blockchain tech- estimated to exceed $601 billion in 2015. Of nology to allow users to send remittances to that amount, developing economies received the Philippines with almost no fees. Other an estimated $441 billion. The following de- companies such as Abra also use blockchain veloping economies were among the top re- technology for money transfers worldwide. cipients of global remittances as a percentage In fact, innovative digital providers seem to of GDP in 2015: Tajikistan (42 percent), Ne- be putting effective pressure on cross-border pal (29 percent), Moldova (26 percent), Haiti transfer costs, which have been declining since (23 percent), and Honduras (17 percent). 2011. The cost of sending remittances fell GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 113 by 1.7 percentage points between 2011 and percent in 2011 to 22 percent in 2015 (panel 2015, from 9.1 percent in 2011 to 7.4 percent a, figure 3.12). Although bank prices have also in 2015 (panel a, figure 3.12). This pattern declined over time, they were still significantly is explained in part by the fact that banks, higher than the ones being charged by MTOs which charge very high fees to channel remit- by 2015. During that year, the cost of sending tances, have significantly reduced their market remittances through the banking system was share in the remittances market over the years. 3.2 percentage points higher than the cost of The share of remittance transactions handled sending them through the traditional MTOs by banks relative to those handled by money (Western Union, MoneyGram, and Ria) and transfer operators (MTOs) declined from 33 5.9 percentage points higher than through FIGURE 3.12 The Remittances Market, 2011–16 a. Average cost of sending remittances b. Banks’ share of remittances market 14 35 13 30 12 Cost (% of amount sent) 11 25 10 20 Percent 9 15 8 7 10 6 5 5 4 0 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016 Banks Traditional MTOs Global average Newer MTOs c. Speed of transactions 80 70 60 50 Percent 40 30 20 10 0 Less than 1 hour Same day Next day 2 days 3–5 days 6 days or more Banks Traditional MTOs Newer MTOs Source: Remittance Prices World Wide (database), World Bank. See http://remittanceprices.worldbank.org. Note: Panel a shows the average total cost (as a percentage of the remittance) of sending $200 internationally; panel b shows the banks’ market share of the remittances market; and panel c shows the average speed of transaction by different methods of sending remittances for the period 2011–16. MTO = money transfer operator. 114 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 the newer MTOs such as Transfer Wise and is large, the rapid spread of digital technolo- Azimo. Because MTOs provide faster trans- gies to access financial services holds special action services than banks, they have also al- potential to overcome the traditional barri- lowed faster international transactions world- ers and financially include the traditionally wide (panel c, figure 3.12). excluded segments (Demirgüç-Kunt, Kane, Increased competition and efficiency are and Laeven 2014).27 For example, mobile among the main contributions that digital in- money platforms allow unbanked consum- novators could make to the traditional global ers, through the use of basic mobile phones, financial sector, especially if a significant com- to make and receive payments much faster (in ponent of financial sector growth over the a matter of seconds) and at a lower cost than last 40 years has been rent seeking (Zingales in the recent past.28 They also provide the in- 2015). For example, according to Philippon frastructure and generate the digitalized data (2015), the unit cost of financial interme- that can be used to create and tailor new fi- diation in the United States has remained at nancial offerings for the financially excluded. about 2 percent for the last 130 years, de- One example is M-Shwari in Kenya, which le- spite several financial innovations.25 In other verages the mobile money infrastructure and words, the improvements in technology have digital information of M-Pesa to make credit- not been yet transmitted to the end users of scoring decisions (CGAP 2015). One of the financial services. However, such a scenario benefits of blockchain technology (see figure might change with the entry of new com- 3.11) for financial inclusion is its potential petitors, thereby broadening the competitive to reform and improve property ownership landscape in terms of number of players, al- through blockchain registries such as Bitfury, ternative products, and business models. The which would generate proof of collateral (an current fintech trend is therefore an opportu- important problem in developing nations) and nity to alleviate the tension between private thus access to credit. Furthermore, because and social returns as well as increase the over- the digital currencies supported by blockchain all efficiency of the system (Philippon 2016). technology are also a global means of pay- Lower costs are achievable not only through ment by design, their impact goes beyond the increased competition but also through the financial arena, as they also facilitate inclu- streamlined processes made possible by the sion in global trade. For example, producers new electronic platforms, which allow the in- in Africa can meet demand in Europe through novating businesses to offer prices lower than the use of online platforms and e-payments. those of the traditional banking services. In fact, the economic gains from widespread The development of fintech also promotes use of digital finance in developing econo- financial inclusion. Access to financial ser- mies would be significant. According to the vices allows consumers in developing econo- McKinsey Global Institute (2016), the in- mies to make longer-term consumption and creased productivity and investment that the investment decisions.26 Historically, there has widespread use of digital finance generates been a wide gap between the financial needs could boost the annual GDP of all develop- of households and businesses in developing ing economies by 6 percent by 2025 versus a economies and the set of financial products business-as-usual scenario. available to them. Among the traditional bar- Despite the potential benefits, fintech ser- riers of the banking sector faced by this seg- vices also pose new types of risks. The lack of ment have been the high costs relative to the safety nets in the business models, misuse of small transaction values involved and the dif- personal data, difficulties in identifying cus- ficulties in identifying and assessing risk. Be- tomers, and electronic fraud are among the cause mobile phone penetration in develop- main vulnerabilities of the new digital finan- ing economies is usually higher than banking cial practices. For example, P2P lending plat- penetration (which is often highly underde- forms, whose business model is based on loan veloped), and the share of cash transactions matching between borrowers and investors GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 115 (charging fees for that service), do not hold prevail. However, excessive regulation might the loans originated in their balance sheets. not be desirable, as it may be deadly for fin- Therefore, although these fintech companies tech start-ups. Understating this, regulators do not bear the default risk, the profitability in some economies are developing regulatory of their businesses is highly dependent on the sandboxes to manage the transition to a new number of loans they intermediate, and thus financial landscape. The aim of this approach it might evaporate during economic reces- is twofold. On the one hand, it allows fintech sions, whereas banks covered by explicit and companies to live test their services with real implicit deposit insurance schemes are better customers while facing a low level of regula- equipped to cope with economic downturns tion during a predefined period of time. On (Demirgüç-Kunt, Kane, and Laeven 2014). the other hand, it helps financial authorities Finally, the new credit assessment techniques to better understand the functioning of these that the P2P models incorporate into their new services as well as their advantages and processes might involve discriminatory sys- risks, ensuring that appropriate consumer tems against borrowers in poorer areas and protection safeguards are built into the new other vulnerable segments (U.S. Department products and services before they reach the of the Treasury 2016). As for payments, the mass market (Financial Conduct Authority anonymity, speed, and global reach of some 2015). The United Kingdom has launched digital currencies facilitates the funding of il- its sandbox, and other economies, such as legal activities. For example, the “Silkroad” Australia, Singapore, and Hong Kong SAR, was an anonymous e-commerce platform that China, are pursuing similar initiatives (Finan- allowed for the trading of any type of prod- cial Times 2016a). The sandbox strategy has uct (including illegal ones) through the use also been contemplated by U.S. regulators of Tor (an anonymous browser) and bitcoin (Wall Street Journal 2016). The new digitally (an anonymous form of payment). These are enabled methods could also be used to ad- some of the risks that have been identified so dress compliance requirements and to moni- far, but there still exist several unknown risks tor digital financial services (“regtech”)—see related to the new digital financial providers. Arner, Barberis, and Buckley (forthcoming) At the center of the policy debate is how and Financial Times (2016b). this new area of finance should be regulated Despite the rapid expansion of fintech and supervised. For example, lending dis- companies, so far the level of disruption seems crimination against some customers, disclo- to be low. To date, about 1 percent of the con- sure requirements for SMEs, and the shar- sumer banking revenue in North America has ing of customer data, are some of the areas been disrupted by fintech players (Citigroup of concern for U.S. regulators brought by the 2016).30 Moreover, total household and SME new online platforms (Politico 2016). Recent lending intermediated by online platforms re- irregularities in the P2P intermediation pro- mains small. According to Citigroup (2016), cess have also led to calls for stricter regula- household lending intermediated through tion.29 Moreover, consumer protection and P2P platforms remains at less than 1 percent education measures are much needed because of total retail loans outstanding in the United many fintechs serve segments of more vulner- States and the United Kingdom. Although able customers (some of them are accessing online credit to SMEs has grown continually financial services for the first time). Another since 2008, it represented less than $10 bil- area of concern is the cross-border activity of lion in outstanding loans in the United States the new digital financial services. Although by 2013, compared with a total of $700 bil- many fintech companies operate globally or lion in bank credit outstanding for small busi- offer digital products involving multiple econ- nesses (Mills and McCarthy 2014).31 More- omies, financial regulation remains region- over, as noted earlier, nonbank MTOs have specific and highly fragmented. Therefore, gained a considerable share of the remittance it is not clear which economy’s laws should business. However, the MTO dominating the 116 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 nonbank market is Western Union, a tradi- Finally, because a bank account is needed to tional player, and yet it is holding about 15 perform many of the new fintech services, it percent of the total market share. This tra- would be hard to imagine fintech companies ditional MTO provides more expensive ser- overtaking banks completely and becoming vices than the new initiatives, but it allows the involved in the current accounts niche. There transfer of cash in real time and without the will always be a need for that highly regulated need for bank accounts (a useful feature in service, which allows households and firms developing economies). Meanwhile, the vol- to keep their money safe and accessible, and ume of cryptocurrency transactions is rather banks seem to be the players best suited to limited compared with other electronic means do that. (Schuh and Shy 2016), and the potential uses Despite their small scale, fintech firms and of blockchain for other applications are still the newly developed digital technologies in in their infancy. the global financial sector are expected to con- The low level of disruption to date is tinue gaining importance over the years, and driven in part by the complementarity of the incumbents are responding with collaborative services provided by many fintech providers strategies. Meanwhile, the trend toward digi- and traditional banks. In many instances, the talization and technological innovation will new fintech companies complement (rather likely reshape the global financial sector and than substitute for) traditional banking, the ways in which financial companies inter- bringing alternative sources of external fi- act with their customers. For example, some nance to households and SMEs. For example, global banks appear to be already shifting a large fraction of the market value in fintech their distribution channels from brick-and- has been created within the relatively new mortar operations to nonphysical channels, e-commerce ecosystem, which includes firms which will probably be the main channel of such as Alipay in China and Paypal in the interaction between banks and consumers in United States. So, in that case, it seems like the future. The proliferation of mobile de- an opportunity lost rather than a loss of ex- vices and new demographics are two of the isting earnings. Moreover, online lending is driving forces in this development, as well as an alternative for the types of borrowers usu- the new solutions and products that are bet- ally underserved by traditional banks: SMEs ter addressing customer needs by increasing and higher-risk households. This alternative accessibility, speed, and convenience. These lending method expanded worldwide dur- developments are likely increasing customer ing the banking crunch that followed the expectations for financial services, and banks global financial crisis, which hit small firms will find it difficult to control all parts of the relatively hard. Since then, SMEs have been value chain using traditional business mod- less able to secure traditional bank credit, els (Forrester Consulting 2015; PwC 2011). and the new online lenders have opened up Recognizing this, banks seem to be shifting new pools of capital for them (Mills and Mc- toward viewing fintech companies as partners Carthy 2014). This is of special relevance and enablers rather than disruptors and com- for households and firms in the developing petitors (Economist Intelligence Unit 2015). world, where the banking system is often Incumbent banks are realizing that they need underdeveloped, but also for underserved to take advantage of fintech capabilities to borrowers in high-income economies. For grow business, retain existing customers, example, Roure, Pelizzon, and Tasca (2016) and attract new ones (some of them previ- find that P2P loans in Germany serve riskier ously unbanked) in the medium to long runs. customers than traditional bank loans. Bla- Meanwhile, without access to a client base, seg and Koetter (2016) show that young client trust, capital, licenses, and a robust firms in Germany are more likely to use global infrastructure, the new fintech compa- online equity crowdfunding platforms when nies will discover that there are limits to their their banks are affected by credit crunches. growth. Collaboration between incumbents GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S 117 and new players is already taking place, and 4. The ACIA, which came into effect in March incumbent financial institutions seem to be 2012, aims to boost cross-border investments pouring increasing amount of investments across ASEAN economies by establishing a into the fintech sector through fintech acqui- free, open, transparent, and integrated invest- sitions, fintech investment funds, and fintech ment regime. The ACMF is a forum compris- ing capital market regulators from Brunei incubators and accelerators (KPMG 2016). Darussalam, Cambodia, Indonesia, the Lao People’s Democratic Republic, Malaysia, NOTES Myanmar, the Philippines, Singapore, Thai- land, and Vietnam. It seeks to achieve greater 1. In the context of this chapter, the “North” integration of the region’s capital markets comprises Austria, Belgium, Canada, Den- through the harmonization of capital market mark, Finland, France, Germany, Greece, Ice- regulations. land, Ireland, Italy, Japan, Luxembourg, the 5. Several reports have already highlighted the Netherlands, Norway, Portugal, San Marino, rising presence of the South in international Spain, Sweden, Switzerland, the United King- finance, which has accounted for most of the dom, and the United States. The “South” growth in world capital flows since the 1990s includes all other economies not in the North. (Aykut and Goldstein 2006; Aykut and Ratha Throughout this chapter, offshore financial 2004; Broner and others 2017; de la Torre centers are excluded from the analysis. and others 2015; World Bank 2006, 2011, 2. Data on international bank claims consider 2013). the asset side and use the liability side to aug- 6. With the exception of South–North bank ment incomplete reporting. Countries in the claims, which have expanded at a slower pace North have reported consistently since the than North–North claims. 1980s, implying good coverage of North– 7. The largest 20 economies in the South are North and North–South transactions and classified according to their GDP in 2014. reasonable coverage of South–North trans- 8. Interregional lending refers to cross-border actions (through the liabilities reported by transactions with economies outside the countries in the North). Reporting of South– region, whereas intraregional lending refers South transactions remains relatively sparse, to cross-border transactions with economies arguably leading to an underestimation of the inside the region. value of these connections. 9. The Gulf Cooperation Council economies are Locational banking statistics categorize Bahrain, Kuwait, Oman, Qatar, Saudi Ara- banks according to the residency principle. bia, and the United Arab Emirates. For example, the claims that Spanish bank 10. For cross-border bank claims, old connec- branches and subsidiaries operating in Chile tions are those country-pair links that were might have in Brazil would be counted as established in 2001, and the new connections Chilean claims on Brazil, not as Spanish are those that were established later. For claims on Brazil, as the BIS Consolidated cross-border syndicated loans, old connec- Banking Statistics would report. tions are those country-pair links that were 3. Because flows are more volatile than stocks, established in the period 1996–2001, and syndicated loans are averaged across years, new connections are those that were estab- and different time periods are used to describe lished later. the trends in cross-border bank claims (2001 11. Total EAP lending to the South (EAP-South) versus 2014) and syndicated loans (1996– also includes cross-border intraregional lend- 2001 versus 2002–14). ing (EAP-EAP). The value of each syndicated loan is 12. For example, the three largest Icelandic banks divided equally among the number of lend- increased their assets from 100 percent of ers, splitting each transaction into several GDP in 2000 to more than 800 percent by loans with a common borrower and different 2007 (Wade and Sigurgeirsdottir 2011). lenders. Data are then aggregated at the bilat- 13. However, increasing regionalization could eral country level by summing the value of all also constrain the global diffusion of banking transactions from a given source economy to technology and practices across economies a given recipient economy for every year in as well as the efficient allocation of capital the sample. around the world. 118 C R O S S - B O R D E R L E N D I N G B Y I N T E R N AT I O N A L B A N K S GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 14. One indication of the increased size and 21. However, the first P2P lending platform was sophistication of developing economies’ launched in 2005 by Zopa in the United financial systems is the growing presence of Kingdom. their banks in syndicated lending—syndi- 22. Electronic payments accounted for 68 per- cated loans typically include banks that are cent of U.S. transactions in 2012 (World Eco- relatively reliable and well known. nomic Forum 2016b). 15. This section is based on transaction-level data 23. The bitcoin system emerged in 2008 in a on corporate bonds and syndicated loans paper published by Nakamoto (2008), the issued domestically and internationally, con- alias used by the author, whose actual identity sidering issuances by both listed and nonlisted is still unknown. firms with an original maturity of one year or 24. See https://blockchain.info. longer. Classification of corporate bonds as 25. Bazot (2013) finds similar results in other domestic or international was undertaken by major countries such as France, Germany, comparing the market location of the bond and the United Kingdom. issuance with the issuing firm’s nationality. 26. See World Bank (2014) and Cull, Ehrbeck, For syndicated loans, the nationality of the and Holle (2014) for a summary of the banks that participate in the deal is used to research on the economic benefits of financial distinguish between domestic and cross- inclusion. border lending. Following the criterion used 27. According to the Global Findex Database in the previous section, syndicated loans are (http://www.worldbank.org/en/programs/ divided into tranches according to the num- globalfindex), over 2 billion people are finan- ber of lenders. Domestic loans are defined as cially excluded, but 90 percent of them have those loans in which the nationality of the access to mobile phones. lender bank is the same as the one of the issu- 28. Mobile payment options are growing more ing firm. Data on firms’ capital-raising activ- slowly in some high-income markets such ity come from the SDC Platinum database. as the United States, where the share of cash Financial sector issuances are excluded transactions is much lower (about 14 per- throughout this section. cent of all transactions) and the established 16. This approach is similar to the one pioneered electronic payment system (credit and debit by Khwaja and Mian (2008) for firms bor- cards) is well developed and efficient (Crowe, rowing from different banks within a country Rysman, and Stavins 2010). and addresses the concern about composi- 29. For example, Lending Club, the largest P2P tional changes in the set of firms raising debt. platform in the United States, which became 17. See Cortina, Didier, and Schmukler (2016) public in 2014, encountered irregularities in for details about calculation of the logit its loan origination and trading processes that regressions. caused its shares to plummet and its CEO to 18. Switching issuers not only changed the com- resign (Reuters 2016). The failure of several position between bond and loan issuances P2P platforms in Asia also led to calls for after 2008, but also compensated for the more regulation (Ecns.cn 2016). decline in syndicated loan financing—that is, 30. According to Citigroup (2016), consumer for those issuers, the increase in the amount banking revenue in North America disrupted raised through corporate bonds during the by fintech companies is projected to grow to crisis years compensated for the decline in about 17 percent by 2023. their syndicated loan issuances. 31. In a recent survey, only about 2 percent of 19. See Pesenti and Tille (2000) for a review of SMEs in the United States reported using this topic. nonbank loans (NSBA 2016). 20. See http://www.businessinsider.com/william -garrity-associates-global-fintech-heat-map -2015-9?r=UK&IR=T. Statistical Appendixes This section consists of two appendixes. Appendix A presents basic economy-by- These appendixes present only a small part of economy data on fi nancial system character- the Global Financial Development Database istics around the world. It also presents aver- (GFDD), available at http://www.worldbank ages of the same indicators for peer groups of .org/financialdevelopment. The 2017/2018 countries, together with summary maps. It is Global Financial Development Report an update on information from the 2015/2016 is also accompanied by Financial Devel- Global Financial Development Report. opment Data Tables, which is a concise online edition of the GFDD for conve- Appendix B provides additional economy- nient reference, available at http://data by-economy information on key aspects of .worldbank.org/ldbfd. It presents country-by- international banking around the world. It country and also regional data for a larger set is specific to the 2017/2018 Global Financial of variables than what are shown here. Development Report. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 119 GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX A 121 APPENDIX A BASIC DATA ON FINANCIAL SYSTEM CHARACTERISTICS, 2013–15 TABLE A.1 Economies and Their Financial System Characteristics, 2013–15 Financial institutions Financial markets Market capitalization Private credit Account Bank excluding top Stock by deposit at a formal lending- Stock market 10 companies market money banks financial deposit capitalization to total market turnover to GDP institution spread Bank to GDP capitalization ratio Stock price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Afghanistan 3.8 9.6 10.8 Albania 37.2 34.7 6.6 15.3 Algeria 17.6 44.7 6.3 21.1 Andorra 22.4 Angola 20.4 32.6 13.0 11.3 Antigua and Barbuda 61.9 7.2 32.2 Argentina 11.7 44.5 3.2 7.3 7.9 30.1 7.3 34.0 Armenia 41.9 17.3 5.1 9.6 1.2 0.8 Aruba 61.5 6.5 24.5 Australia 125.8 98.9 3.1 7.6 87.7 52.8 58.8 12.2 Austria 89.1 96.8 3.4 20.3 24.8 40.7 28.7 18.7 Azerbaijan 28.3 24.4 8.5 2.8 0.1 Bahamas, The 75.5 3.2 16.6 Bahrain 67.5 76.1 4.6 15.5 62.2 27.7 2.2 7.1 Bangladesh 40.1 30.0 2.8 7.8 14.5 65.1 15.2 Barbados 77.5 6.3 13.1 107.3 0.4 Belarus 21.2 67.5 0.2 4.4 Belgium 57.1 97.5 5.2 14.7 72.3 30.2 15.7 Belize 55.4 48.2 7.9 8.1 Benin 21.9 14.1 2.0 10.9 Bermuda 13.7 3.0 15.3 Bhutan 43.0 33.7 9.3 32.7 9.6 Bolivia 42.1 36.5 7.6 9.7 15.9 0.4 Bosnia and Herzegovina 52.5 53.9 3.9 7.8 13.5 9.2 Botswana 30.9 42.9 6.3 10.1 28.5 2.7 3.6 Brazil 66.4 64.0 24.3 10.5 37.2 48.9 72.4 22.7 Brunei Darussalam 34.2 5.2 9.0 Bulgaria 61.8 59.6 6.7 8.9 13.6 5.0 14.3 Burkina Faso 25.8 13.4 3.2 7.4 Burundi 16.5 7.0 8.0 11.6 Cabo Verde 61.8 7.1 23.7 Cambodia 48.3 9.6 10.7 Cameroon 14.6 12.5 10.8 11.2 Canada 126.6 98.0 2.5 14.0 106.0 72.3 64.4 11.1 (appendix continued next page) 122 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 TABLE A.1 Economies and Their Financial System Characteristics, 2013–15 (continued) Financial institutions Financial markets Market capitalization Private credit Account Bank excluding top Stock by deposit at a formal lending- Stock market 10 companies market money banks financial deposit capitalization to total market turnover to GDP institution spread Bank to GDP capitalization ratio Stock price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Cayman Islands 17.1 1.0 Central African Republic 13.8 3.3 10.8 7.4 Chad 7.9 8.1 10.8 11.9 Channel Islands 0.1 Chile 75.5 56.2 3.4 7.1 91.8 54.4 12.0 12.6 China 132.4 73.9 2.9 22.7 50.7 81.1 331.6 20.7 Colombia 40.5 35.7 6.8 7.8 46.1 25.8 10.3 14.9 Comoros 23.2 21.7 8.8 Congo, Dem. Rep. 5.4 8.5 15.0 4.6 Congo, Rep. 14.5 14.5 10.8 5.0 Costa Rica 51.0 59.8 11.6 18.2 3.8 1.9 37.9 Côte d’Ivoire 18.7 15.1 1.0 6.6 35.8 3.7 Denmark 178.7 99.9 4.7 13.6 61.2 53.5 16.2 Croatia 68.8 86.8 7.7 4.7 37.0 2.4 9.2 Cuba 14.0 Curaçao 7.8 Cyprus 255.3 88.5 3.3 6.0 12.5 10.7 2.7 45.6 Czech Republic 49.6 81.7 3.9 4.5 17.6 28.1 15.2 Djibouti 29.4 12.3 10.6 16.4 Dominica 54.9 6.1 10.0 Dominican Republic 23.3 48.7 7.7 22.3 0.7 Ecuador 26.3 43.1 9.7 5.1 6.7 2.3 5.9 Egypt, Arab Rep. 25.2 12.3 4.7 18.6 20.3 52.8 28.8 23.7 El Salvador 41.0 27.7 4.6 24.9 34.1 0.6 Equatorial Guinea 9.8 10.8 17.5 Eritrea 12.7 6.3 Estonia 69.3 97.4 4.4 9.3 8.5 9.4 10.7 Ethiopia 17.2 21.8 3.3 7.5 Fiji 58.3 3.7 25.3 10.7 1.6 Finland 92.9 99.9 2.7 10.2 57.2 86.1 16.9 France 94.9 96.7 4.4 19.7 76.9 53.2 18.2 Gabon 14.1 26.4 10.8 10.9 Gambia, The 13.6 12.8 6.3 Georgia 41.0 37.4 3.6 6.2 5.5 0.2 Germany 79.7 98.6 7.0 22.6 46.9 54.5 78.6 17.1 Ghana 16.0 32.9 9.1 7.2 7.5 1.7 8.1 GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX A 123 TABLE A.1 Economies and Their Financial System Characteristics, 2013–15 (continued) Financial institutions Financial markets Market capitalization Private credit Account Bank excluding top Stock by deposit at a formal lending- Stock market 10 companies market money banks financial deposit capitalization to total market turnover to GDP institution spread Bank to GDP capitalization ratio Stock price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Gibraltar 31.1 Greece 117.8 84.3 4.3 7.6 26.2 19.9 42.1 37.0 Grenada 67.5 6.9 11.9 Guatemala 31.3 34.6 8.1 21.9 0.8 6.6 Guinea 10.3 5.3 11.9 5.2 Guinea-Bissau 11.9 4.2 4.8 Guyana 35.0 11.9 22.2 18.4 0.3 Haiti 17.4 19.0 8.3 19.2 Honduras 53.0 26.9 9.7 31.8 684.5 Hong Kong SAR, China 211.5 93.7 5.0 17.6 1062.4 66.0 51.3 16.5 Hungary 43.6 72.4 3.0 3.2 13.2 3.4 48.2 18.1 Iceland 102.7 7.2 3.1 16.6 29.1 11.2 India 49.7 46.9 8.9 66.3 71.7 50.9 15.6 Indonesia 30.7 30.5 4.5 4.1 40.9 54.2 24.3 17.1 Iran, Islamic Rep. 48.3 86.0 0.1 41.9 50.7 15.9 Iraq 7.4 10.8 27.6 Ireland 95.3 94.4 2.6 10.0 60.8 8.8 12.6 15.8 Israel 64.7 90.1 3.0 24.7 67.1 42.3 26.4 11.4 Italy 90.5 81.9 4.9 9.9 27.4 38.1 273.5 24.2 Jamaica 28.4 75.9 12.7 8.0 45.2 3.1 11.9 Japan 103.9 96.6 0.8 14.0 86.7 83.1 135.0 20.3 Jordan 69.0 24.9 4.5 33.2 72.7 35.1 13.0 7.9 Kazakhstan 34.1 50.0 2.1 11.7 17.0 5.6 23.6 Kenya 31.0 50.9 7.9 16.5 25.4 7.9 10.7 Korea, Rep. 127.7 93.9 1.7 9.9 89.6 67.0 122.1 12.9 Kosovo 33.0 46.6 9.7 Kuwait 72.5 77.5 2.3 14.7 56.7 23.3 10.2 Kyrgyz Republic 17.3 13.6 20.2 18.6 2.4 3.4 Lao PDR 18.9 26.8 19.6 7.2 17.5 Latvia 54.7 90.0 5.8 4.3 3.7 3.0 14.0 Lebanon 92.8 43.6 1.3 20.8 23.8 4.0 7.1 Lesotho 19.2 18.5 7.6 8.4 Liberia 16.7 18.8 9.5 10.0 Libya 14.5 3.5 30.3 Lithuania 42.0 76.5 4.3 5.6 9.2 4.4 9.0 Luxembourg 90.6 95.6 2.0 34.8 106.5 4.7 0.2 15.7 (appendix continued next page) 124 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 TABLE A.1 Economies and Their Financial System Characteristics, 2013–15 (continued) Financial institutions Financial markets Market capitalization Private credit Account Bank excluding top Stock by deposit at a formal lending- Stock market 10 companies market money banks financial deposit capitalization to total market turnover to GDP institution spread Bank to GDP capitalization ratio Stock price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Macao SAR, China 74.5 5.2 17.8 Macedonia, FYR 47.3 72.4 3.9 5.3 5.7 5.6 15.4 Madagascar 11.8 5.7 47.3 6.3 Malawi 11.2 16.3 30.5 10.6 13.7 2.0 Malaysia 116.4 75.8 1.5 16.0 138.8 64.0 29.7 8.6 Maldives 31.8 7.2 9.5 Mali 22.3 11.6 3.3 7.6 Malta 102.3 96.0 2.6 13.8 37.8 10.8 1.9 8.4 Mauritania 27.5 19.5 11.2 19.9 Mauritius 102.0 81.5 1.9 14.8 67.0 40.2 5.1 4.4 Mexico 21.7 34.9 2.8 18.8 38.4 44.3 27.5 14.0 Micronesia, Fed. Sts. 20.8 15.0 23.7 Moldova 34.5 17.9 4.2 6.7 2.7 111.8 Monaco 17.9 Mongolia 53.3 87.1 6.6 21.4 11.7 2.9 17.2 Montenegro 51.3 56.7 7.2 86.6 1.2 13.4 Morocco 66.4 39.1 8.0 39.9 48.1 28.4 6.0 9.0 Mozambique 28.2 39.9 6.4 4.0 Myanmar 13.3 22.6 5.0 2.5 Namibia 47.4 58.1 4.5 7.9 8.9 1.8 17.6 Nepal 55.6 31.0 4.4 25.4 20.1 1.3 Netherlands 115.3 99.1 0.2 8.9 90.5 60.4 15.0 New Zealand 139.2 99.5 1.8 24.0 52.4 56.2 13.4 8.1 Nicaragua 29.0 17.3 12.5 12.2 Niger 13.8 2.8 3.5 11.0 Nigeria 12.8 39.3 7.9 9.4 12.2 28.2 8.1 14.8 Norway 109.1 100.0 2.0 8.6 47.6 26.0 44.7 15.7 Oman 48.6 73.6 3.0 15.5 48.2 66.2 13.9 10.4 Pakistan 15.4 9.2 4.8 10.8 16.9 31.5 13.0 Panama 69.2 37.2 4.8 25.6 30.8 1.0 6.3 Papua New Guinea 25.0 9.1 6.4 68.0 0.6 Paraguay 46.7 21.7 16.0 12.7 3.8 5.6 Peru 31.7 26.1 14.4 14.8 39.3 37.9 3.3 15.5 Philippines 36.2 27.6 4.1 15.7 83.1 60.1 17.8 17.2 Poland 51.3 75.3 3.3 8.0 33.6 45.4 35.3 17.1 GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX A 125 TABLE A.1 Economies and Their Financial System Characteristics, 2013–15 (continued) Financial institutions Financial markets Market capitalization Private credit Account Bank excluding top Stock by deposit at a formal lending- Stock market 10 companies market money banks financial deposit capitalization to total market turnover to GDP institution spread Bank to GDP capitalization ratio Stock price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Portugal 134.7 85.3 2.8 12.9 29.7 63.5 18.7 Puerto Rico 69.7 Qatar 47.9 65.9 3.4 24.5 86.2 27.6 20.1 12.8 Romania 32.3 55.4 5.4 4.7 10.2 12.3 13.3 Russian Federation 52.2 61.0 5.2 5.2 28.4 38.7 32.3 20.7 Rwanda 18.6 36.4 9.2 6.4 Samoa 41.5 7.1 12.0 San Marino 123.5 9.2 São Tomé and Príncipe 27.6 13.0 2.9 Saudi Arabia 44.8 61.7 14.6 63.2 47.0 100.7 15.8 Senegal 31.4 9.9 1.0 5.4 Serbia 43.9 76.1 8.4 11.4 17.7 4.0 11.0 Seychelles 21.5 9.1 8.7 Sierra Leone 4.7 14.5 12.9 4.9 Singapore 124.4 97.0 5.2 19.8 240.5 72.9 31.2 10.3 Slovak Republic 48.8 78.0 2.0 14.4 4.9 2.3 17.4 Slovenia 61.6 97.2 4.5 2.1 14.6 62.7 7.3 16.4 Solomon Islands 20.4 10.4 Somalia 15.6 South Africa 65.9 63.7 3.3 13.4 245.2 77.2 28.2 13.8 South Sudan 1.4 12.2 8.3 Spain 134.5 96.1 1.8 18.7 73.8 32.2 100.5 21.4 Sri Lanka 26.2 78.0 0.6 11.4 25.7 59.6 9.7 10.3 St. Kitts and Nevis 59.8 5.9 13.6 81.1 0.9 St. Lucia 103.2 6.3 4.8 St. Vincent and the Grenadines 52.3 6.8 15.3 Sudan 8.0 12.5 23.8 Suriname 28.1 5.0 14.9 Swaziland 19.3 28.6 6.6 14.8 6.3 1.7 Sweden 127.9 99.5 2.5 11.9 92.8 74.5 15.8 Switzerland 169.3 98.0 2.7 13.9 213.7 29.2 54.3 14.2 Syrian Arab Republic 20.4 23.3 3.7 10.7 Taiwan, China 90.0 13.3 69.7 Tajikistan 17.0 8.5 19.5 12.0 Tanzania 12.8 18.4 6.2 11.9 4.3 1.6 14.5 (appendix continued next page) 126 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 TABLE A.1 Economies and Their Financial System Characteristics, 2013–15 (continued) Financial institutions Financial markets Market capitalization Private credit Account Bank excluding top Stock by deposit at a formal lending- Stock market 10 companies market money banks financial deposit capitalization to total market turnover to GDP institution spread Bank to GDP capitalization ratio Stock price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Thailand 111.6 76.3 4.7 3.2 93.5 62.9 81.8 16.4 Timor-Leste 13.2 12.1 Togo 32.5 15.1 2.9 3.1 Tonga 30.0 6.1 4.9 Trinidad and Tobago 32.2 75.9 6.2 25.3 65.2 0.8 Tunisia 71.2 28.9 2.5 23.2 19.4 14.3 7.0 Turkey 60.4 56.9 7.7 26.9 52.4 175.6 23.9 Turkmenistan 1.3 2.6 Tuvalu 10.9 Uganda 12.4 25.3 10.7 10.6 30.7 0.2 Ukraine 55.2 48.9 6.8 5.2 13.1 5.2 30.6 United Arab Emirates 65.2 75.4 4.4 27.2 45.9 23.3 39.7 15.2 United Kingdom 145.9 98.4 2.7 13.6 112.1 69.0 84.9 12.6 United States 49.5 91.7 27.9 139.5 74.6 156.0 12.6 Uruguay 27.9 38.1 9.6 5.5 0.3 0.8 Uzbekistan 34.6 6.7 5.9 Vanuatu 69.5 3.2 9.7 Venezuela, RB 27.9 52.6 2.8 6.8 3.7 0.3 32.5 Vietnam 96.4 27.7 2.8 5.9 23.6 38.7 17.9 West Bank and Gaza 29.0 22.6 17.6 25.1 9.6 10.6 Yemen, Rep. 5.6 5.5 6.8 19.1 Zambia 12.5 28.0 3.7 2.9 13.8 5.7 Zimbabwe 8.0 24.7 3.4 136.5 0.0 ˇ ihák and others 2013. Source: Data from and calculations based on the Global Financial Development Database. For more information, see C Note: Empty cells indicate a lack of data. NOTES Economy: A territorial entity for which statis- characteristics introduced in the 2013 Global tical data are maintained and provided inter- Financial Development Report, with four nationally on a separate and independent variables approximating depth, access, effi- basis (not necessarily a state as understood ciency, and stability of fi nancial institutions by international law and practice). The term, and financial markets, respectively. used interchangeably with country, does not imply political independence or official Additional data: The table above presents a recognition by the World Bank. small fraction of observations in the Global Financial Development Database, accompa- Table layout: The layout of the table fol- nying this report. For additional variables, lows the 4x2 matrix of financial system historical data, and detailed metadata, see GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX A 127 the full data set at http://www.worldbank the unweighted arithmetic average of the .org/financialdevelopment. rescaled variables (dimensions) for each economy. This average is reported only for Period covered: The table shows averages of those economies for which data for 2013– values for 2013–15, where available. 15 are available for at least four variables (dimensions). Averaging: Each observation is an arithmetic average of the corresponding variable over Private credit by deposit money banks to 2013–15. When a variable is not reported GDP (%) measures the domestic private or not available for a part of this period, the credit to the real sector by deposit money average is calculated using the forwarded banks as a percentage of local currency GDP. value from the most recent observation Data on domestic private credit to the real available. sector by deposit money banks are from the International Financial Statistics (IFS), line Visualization: To illustrate where an econ- FOSAOP/22D, published by the Interna- omy’s observation is in relation to the global tional Monetary Fund (IMF). Local currency distribution of the variable, the table includes GDP is also from IFS. four bars on the left of each observation. The four-bar scale is based on the location of Account at a formal financial institution (%, the economy in the statistical distribution of age 15+) measures the percentage of adults the variable in the Global Financial Develop- with an account (self or together with some- ment Database: values below the 25th per- one else) at a bank, credit union, another centile show only one full bar, values equal financial institution (e.g., cooperative, to or greater than the 25th and less than the microfi nance institution), or the post office 50th percentile show two full bars, values (if applicable), including adults who report equal to or greater than the 50th and less having a debit card. The data are from the than the 75th percentile show three full bars, Global Financial Inclusion (Global Findex) and values greater than the 75th percentile Database (Demirgüç-Kunt, Klapper, and show four full bars. At the economy level, others 2014). bars are calculated using winsorized and res- caled values, as described in the 2013 Global Bank lending-deposit spread (percentage Financial Development Report. To prepare points) is lending rate minus deposit rate. for this, the 95th and 5th percentile for each Lending rate is the rate charged by banks variable for the entire pooled economy-year on loans to the private sector, and deposit data set are calculated, and the top and interest rate is the rate paid by commercial bottom 5 percent of observations are trun- or similar banks for demand, time, or sav- cated. Specifically, all observations from the ings deposits. The lending and deposit rates 5th percentile to the minimum are replaced are from IFS lines FILR/60P and FIDR/60L, by the value corresponding to the 5th per- respectively. centile, and all observations from the 95th percentile to the maximum are replaced by Bank Z-score is calculated as [ROA + (equity / the value corresponding to the 95th percen- assets)] / (standard deviation of ROA). To tile. To convert all the variables to a 0–100 approximate the probability that a an econ- scale, each score is rescaled by the maximum omy’s banking system defaults, the indica- and the minimum for each indicator. The tor compares the system’s buffers (returns rescaled indicator can be interpreted as the and capitalization) with the system’s riski- percent distance between the worst (0) and ness (volatility of returns). Return on Assets the best (100) financial development out- (ROA), equity, and assets are economy-level come, defined by the 5th and 95th percen- aggregate figures (calculated from underly- tiles of the original distribution. The four ing bank-by-bank unconsolidated data from bars on the left of the economy name show Bankscope and Orbis Bank Focus). 128 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 Stock market capitalization to GDP (%) mea- total market capitalization. The WFE pro- sures the capitalization of all equity markets vides data on the exchange level. This vari- as percentage of GDP. Market capitalization able is aggregated up to the economy level by (also known as market value) is the share taking a simple average over exchanges. price times the number of shares outstanding. Listed domestic companies are the domesti- Stock market turnover ratio (%) is the total cally incorporated companies listed on the value of shares traded during the period economy’s stock exchanges at the end of the divided by the average market capitaliza- year. Listed companies do not include invest- tion for the period. Average market capi- ment companies, mutual funds, or other col- talization is calculated as the average of the lective investment vehicles. Data are from end-of-period values for the current period World Federation of Exchanges (WFE), Stan- and the previous period. Data are from the dard & Poor’s Global Stock Markets Fact- WFE, Standard & Poor’s Global Stock Mar- book, and supplemental Standard & Poor’s kets Factbook, and supplemental Standard & data, and are compiled and reported by the Poor’s data, and are compiled and reported World Development Indicators. by the World Development Indicators. Market capitalization excluding top 10 com- Stock price volatility is the 360-day stan- panies to total market capitalization (%) dard deviation of the return on the primary measures the ratio of market capitalization national stock market index. The data are outside of the top 10 largest companies to from Bloomberg. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX A 129 MAP A.1 DEPTH—FINANCIAL INSTITUTIONS To approximate financial institutions’ depth, this FOSAOP/22D, published by the International Mon- map uses domestic private credit to the real sector etary Fund (IMF). Local currency GDP is also from by deposit money banks as a percentage of local IFS. The four shades of blue in the map are based currency GDP. Data on domestic private credit to on the average value of the variable in 2013–15: the the real sector by deposit money banks are from darker the blue, the higher the quartile of the statisti- the International Financial Statistics (IFS), line cal distribution of the variable. TABLE A.1.1 Depth—Financial Institutions Private credit by deposit money banks to Number of Standard Weighted GDP (%) countries Average Median deviation Minimum Maximum average World 185 51.4 41.5 41.3 1.4 255.3 83.1 By developed/developing economies Developed economies 56 89.6 76.5 46.1 21.5 255.3 85.9 Developing economies 129 34.9 28.4 24.9 1.4 132.4 78.3 By income level High income 56 89.6 76.5 46.1 21.5 255.3 85.9 Upper-middle income 50 47.9 45.3 28.7 7.4 132.4 90.1 Lower-middle income 50 32.4 29 18.8 5.6 96.4 38.1 Low income 29 16.6 13.8 10.9 1.4 55.6 17.1 By region High income: OECD 33 97.5 94.9 36.5 43.6 178.7 86 High income: non-OECD 23 78.3 65.2 56.1 21.5 255.3 83 East Asia and Pacific 18 52 38.9 38 13.2 132.4 120.4 Europe and Central Asia 19 40.1 41 13.6 17 61.8 50.6 Latin America and the Caribbean 25 42.2 40.5 20.4 11.7 103.2 42.5 Middle East and North Africa 13 38.2 29 28.2 5.6 92.8 35 South Asia 8 33.2 36 17.5 3.8 55.6 44.7 Sub-Saharan Africa 46 21.3 16.2 17.8 1.4 102 26.6 Source: Global Financial Development Database, 2013–15 data. Note: OECD = Organization for Economic Co-operation and Development. Weighted average by current GDP. 130 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 MAP A.2 ACCESS—FINANCIAL INSTITUTIONS To approximate access to fi nancial institutions, this Inclusion (Global Findex) Database. The four shades map uses the percentage of adults (age 15+) who of blue in the map are based on the value of the vari- reported having an account at a formal financial insti- able in 2014: the darker the blue, the higher the quar- tution. The data are taken from the Global Financial tile of the statistical distribution of the variable. TABLE A.1.2 Access—Financial Institutions Account at a formal fi nancial institution Number of Standard Weighted (%, age 15+) countries Average Median deviation Minimum Maximum average World 157 49.8 43.6 31.5 1.3 100 53.7 By developed/developing economies Developed economies 48 87.1 92.7 13.6 38.1 100 91.1 Developing economies 109 33.4 28 21.5 1.3 87.1 46.5 By income level High income 48 87.1 92.7 13.6 38.1 100 91.1 Upper-middle income 41 49.8 50 19.9 1.3 86 64.8 Lower-middle income 42 28 27.2 17 5.5 87.1 36.2 Low income 26 16.1 14.8 9.6 2.8 39.9 17.1 By region High income: OECD 32 91.8 96.6 10.2 56.2 100 92.5 High income: non-OECD 16 77.7 76.3 15 38.1 97 72.2 East Asia and Pacific 10 45.8 29.1 28.7 9.6 87.1 62 Europe and Central Asia 21 42.6 48.9 21.8 1.3 76.1 52 Latin America and the Caribbean 19 39.7 36.5 15.8 17.3 75.9 46.5 Middle East and North Africa 12 29.5 24.1 22 5.5 86 36.3 South Asia 7 34.1 31 23.6 9.2 78 40.7 Sub-Saharan Africa 40 23.4 18.5 17.3 2.8 81.5 26.2 Source: Global Financial Development Database, 2014 data. Note: OECD = Organization for Economic Co-operation and Development. Weighted average by total adult population in 2014. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX A 131 MAP A.3 EFFICIENCY—FINANCIAL INSTITUTIONS To approximate efficiency of fi nancial institutions, deposits. The lending and deposit rates are from IFS, this map uses the spread (difference) between lend- lines FILR/60P and FIDR/60L, respectively. The four ing rate and deposit interest rate. Lending rate is the shades of blue in the map are based on the average rate charged by banks on loans to the private sector, value of the variable in 2013–15: the darker the blue, and deposit interest rate is the rate paid by commer- the higher the quartile of the statistical distribution cial or similar banks for demand, time, or savings of the variable. TABLE A.1.3 Efficiency—Financial Institutions Number of Standard Weighted Bank lending-deposit spread (%) countries Average Median deviation Minimum Maximum average World 170 6.7 5.2 5.5 0.1 47.3 5.1 By developed/developing economies Developed economies 53 4.1 3.4 2 0.2 9.6 3.8 Developing economies 117 7.9 6.8 6.1 0.1 47.3 6.5 By income level High income 53 4.1 3.4 2 0.2 9.6 3.8 Upper-middle income 46 6.7 6.2 4.6 0.1 24.3 6.1 Lower-middle income 45 7.9 7.1 4.6 0.6 20.2 6.8 Low income 26 10 8.5 9.7 1 47.3 7.9 By region High income: OECD 32 3.3 3 1.6 0.2 7.2 3.2 High income: non-OECD 21 5.3 5.2 2 2.3 9.6 4.8 East Asia and Pacific 17 7 5 4.9 1.5 19.6 4.8 Europe and Central Asia 15 7.2 5.4 5.5 0.2 20.2 6.1 Latin America and the Caribbean 25 8.7 7.7 4.8 2.8 24.3 9.3 Middle East & North Africa 11 4.7 4.5 3.1 0.1 10.6 4 South Asia 6 4.9 4.6 3.1 0.6 9.3 4.9 Sub-Saharan Africa 43 9.1 8 7.9 1 47.3 7.2 Source: Global Financial Development Database, 2013–15 data. Note: OECD = Organization for Economic Co-operation and Development. Weighted average by total banking assets. 132 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 MAP A.4 STABILITY—FINANCIAL INSTITUTIONS To approximate stability of financial institutions, indicator compares the banking system’s buffers this map uses the Z-score for commercial banks. The (returns and capital) with its riskiness (volatility of indicator is estimated as follows: [ROA + (equity / returns). The four shades of blue in the map are based assets)] / (standard deviation of ROA). Return on on the average value of the variable in 2013–15: the assets (ROA), equity, and assets are economy-level darker the blue, the higher the quartile of the statisti- aggregate figures (calculated from underlying bank- cal distribution of the variable. by-bank unconsolidated data from Bankscope). The TABLE A.1.4 Stability—Financial Institutions Number of Standard Weighted Bank Z-score countries Average Median deviation Minimum Maximum average World 192 12.9 10.9 7.7 2.1 39.9 13.7 By developed/developing economies Developed economies 63 14.4 13.7 7.6 2.1 34.8 14 Developing economies 129 12.1 10.5 7.6 2.1 39.9 13.4 By income level High income 63 14.4 13.7 7.6 2.1 34.8 14 Upper-middle income 52 12.6 10.9 7.6 2.1 33.2 13.4 Lower-middle income 49 13.5 10.8 8.4 2.5 39.9 14.8 Low income 28 8.7 7.5 4.8 3.1 25.4 9.2 By region High income: OECD 33 13 11.9 7.6 2.1 34.8 13.3 High income: non-OECD 30 16 15.1 7.5 4.7 32.2 15.3 East Asia and Pacific 17 11.9 10.7 7.6 2.5 25.3 12.7 Europe and Central Asia 21 7.6 6.7 4.1 2.1 18.6 7.7 Latin America and the Caribbean 26 14.6 13.3 7.1 4.8 31.8 14.2 Middle East and North Africa 12 23.2 21 8.1 10.7 39.9 24.5 South Asia 8 14.7 10.8 9.2 7.8 32.7 15.4 Sub-Saharan Africa 45 9.5 8.3 5.1 2.9 23.8 10.4 Source: Global Financial Development Database, 2013–15 data. Note: OECD = Organization for Economic Co-operation and Development. Weighted average by total banking assets. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX A 133 MAP A.5 DEPTH—FINANCIAL MARKETS To approximate depth of financial markets, this map other collective investment vehicles. Data are from uses stock market capitalization as percentage of GDP. WFE, Standard & Poor’s Global Stock Markets Fact- Market capitalization (also known as market value) is book, and supplemental S&P data, and are compiled the share price times the number of shares outstand- and reported by the World Development Indicators. ing. Listed domestic companies are the domestically The four shades of blue in the map are based on the incorporated companies listed on the economy’s stock average value of the variable in 2013–15: the darker exchanges at the end of the year. Listed companies do the blue, the higher the quartile of the statistical dis- not include investment companies, mutual funds, or tribution of the variable. TABLE A.1.5 Depth—Financial Markets Number of Standard Weighted Stock market capitalization to GDP (%) countries Average Median deviation Minimum Maximum average World 117 72.4 38.4 125.3 0.1 1077.7 130.8 By developed/developing economies Developed economies 49 110.8 79.3 154.4 0.3 1077.7 164.3 Developing economies 68 44.8 19.7 90.8 0.1 684.5 68.6 By income level High income 49 110.8 79.3 154.4 0.3 1077.7 164.3 Upper-middle income 35 42.9 24.6 56.1 0.1 262.7 74.1 Lower-middle income 28 47.7 18.1 126.6 0.8 684.5 48.3 Low income 5 41.1 20.1 54.2 4.3 136.5 30.3 By region High income: OECD 33 102.3 99.2 63 3.7 231.4 162.1 High income: non-OECD 16 128.5 59.5 259.4 0.3 1077.7 207 East Asia and Pacific 9 73.2 68 60.5 10.7 190.8 90.1 Europe and Central Asia 15 16.6 11.7 21.8 0.1 86.6 28.4 Latin America and the Caribbean 17 63.1 18.4 161.6 0.7 684.5 50 Middle East and North Africa 7 36 25.1 19.6 19.4 72.7 35 South Asia 6 26.3 18.5 22.6 9.6 71.2 60.1 Sub-Saharan Africa 14 46.7 19.6 71.3 4.3 262.7 90 Source: Global Financial Development Database, 2013–15 data. Note: OECD = Organization for Economic Co-operation and Development. Weighted average by current GDP. 134 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 MAP A.6 ACCESS—FINANCIAL MARKETS To approximate access to financial markets, this map by taking a simple average over exchanges. The four uses the ratio of market capitalization excluding the shades of blue in the map are based on the average top 10 largest companies to total market capitaliza- value of the variable in 2013–15: the darker the blue, tion. The WFE provides data on the exchange level. the higher the quartile of the statistical distribution This variable is aggregated up to the economy level of the variable. TABLE A.1.6 Access—Financial Markets Market capitalization excluding top 10 companies Number of Standard Weighted to total market capitalization (%) countries Average Median deviation Minimum Maximum average World 53 45.7 47 21.1 3.4 83.1 55 By developed/developing economies Developed economies 31 43.8 45.4 23.5 3.4 83.1 54.2 Developing economies 22 48.2 49.8 17.4 17 81.1 56.8 By income level High income 31 43.8 45.4 23.5 3.4 83.1 54.2 Upper-middle income 15 47.1 44.3 18.2 17 81.1 57.4 Lower-middle income 7 50.7 54.2 16.5 28.2 71.7 54.9 Low income 0 By region High income: OECD 21 44.6 45.4 23.4 3.4 83.1 47.9 High income: non-OECD 10 42.2 37.3 25 10.7 72.9 60 East Asia and Pacific 5 64.5 62.9 10 54.2 81.1 64.1 Europe and Central Asia 3 36 38.7 17.9 17 52.4 40.4 Latin America and the Caribbean 5 37.4 37.9 9.6 25.8 48.9 38.1 Middle East and North Africa 4 41.8 42.9 11.9 28.4 52.8 38.9 South Asia 2 65.7 65.7 8.6 59.6 71.7 68.4 Sub-Saharan Africa 3 48.5 40.2 25.5 28.2 77.2 67.7 Source: Global Financial Development Database, 2013–15 data. Note: OECD = Organization for Economic Co-operation and Development. Weighted average by stock market capitalization. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX A 135 MAP A.7 EFFICIENCY—FINANCIAL MARKETS To approximate efficiency of fi nancial markets, this Factbook, and supplemental S&P data, and is com- map uses the total value of shares traded during the piled and reported by the World Development Indi- period divided by the average market capitalization cators. The four shades of blue in the map are based for the period. Average market capitalization is cal- on the average value of the variable in 2013–15: the culated as the average of the end-of-period values for darker the blue, the higher the quartile of the statisti- the current period and the previous period. Data are cal distribution of the variable. from WFE, Standard & Poor’s Global Stock Markets TABLE A.1.7 Efficiency—Financial Markets Number of Standard Weighted Stock market turnover ratio (%) countries Average Median deviation Minimum Maximum average World 116 30.6 9.5 50.5 0 331.6 43.7 By developed/developing economies Developed economies 52 42.2 28.9 50.2 0.1 273.5 51.7 Developing economies 64 21.3 5.6 49.2 0 331.6 28.1 By income level High income 52 42.2 28.9 50.2 0.1 273.5 51.7 Upper-middle income 32 27.9 5.3 65.3 0.2 331.6 38.1 Lower-middle income 27 17.2 6.6 25.1 0.4 111.8 17.2 Low income 5 1 1.3 0.9 0 2 0.3 By region High income: OECD 33 57.3 48.2 54.8 0.2 273.5 66.3 High income: non-OECD 19 15.8 2.7 25.6 0.1 100.7 36.9 East Asia and Pacific 9 58.8 24.3 105.4 0.6 331.6 61.6 Europe and Central Asia 14 26.4 5.4 51.9 0.2 175.6 28.7 Latin America and the Caribbean 15 9.5 3.1 18.7 0.3 72.4 14 Middle East and North Africa 7 13.1 13 8.2 4 28.8 12.3 South Asia 5 31.7 31.5 26.9 1.3 65.1 35.7 Sub-Saharan Africa 14 5 2.4 7.2 0 28.2 12.5 Source: Global Financial Development Database, 2013–15 data. Note: OECD = Organization for Economic Co-operation and Development. Weighted average by stock market capitalization. 136 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 MAP A.8 STABILITY—FINANCIAL MARKETS To approximate stability of fi nancial markets, this in the map are based on the average value of the map uses the 360-day standard deviation of the variable in 2013–15: the darker the blue, the higher return on the primary national stock market index. the quartile of the statistical distribution of the Data are from Bloomberg. The four shades of blue variable. TABLE A.1.8 Stability—Financial Markets Number of Standard Weighted Stock price volatility countries Average Median deviation Minimum Maximum average World 92 15.5 15.1 7.2 3.6 45.6 15.9 By developed/developing economies Developed economies 46 15.6 15.2 6.7 7.1 45.6 15.5 Developing economies 46 15.4 14.7 7.7 3.6 37.9 17.2 By income level High income 46 15.6 15.2 6.7 7.1 45.6 15.5 Upper-middle income 28 15.7 14.1 8.8 3.6 37.9 17.4 Lower-middle income 17 15 15.2 5.9 7 30.6 16 Low income 1 14.5 14.5 14.5 14.5 14.5 By region High income: OECD 33 16.1 15.7 5 8.1 37 15.6 High income: non-OECD 13 14.3 10.4 9.9 7.1 45.6 15.4 East Asia and Pacific 8 16.6 17.2 3.5 8.6 20.7 17.4 Europe and Central Asia 10 17.5 14.8 6.9 9.2 30.6 22.6 Latin America and the Caribbean 10 19.6 15.2 11.6 5.9 37.9 19.2 Middle East and North Africa 6 10.9 8.4 6.4 7 23.7 12.3 South Asia 4 13.5 14.1 2.4 10.3 15.6 15.1 Sub-Saharan Africa 8 10.9 12.2 5.1 3.6 17.6 13.2 Source: Global Financial Development Database, 2013–15 data. Note: OECD = Organization for Economic Co-operation and Development. Weighted average by total value of stocks traded. GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX B 137 APPENDIX B KEY ASPECTS OF INTERNATIONAL BANKING TABLE B.1 Foreign Penetration and Internationalization of Financial Systems, 2014 Foreign bank penetration Internationalization Foreign Foreign Foreign Foreign Foreign developing Foreign developing bank claims bank local bank asset Foreign economy liability economy to GDP claim share share bank share bank share ratio liability ratio Foreign host Economy (%) (%) (%) (%) (%) (%) (%) countries Albania 46.6 78.1 89 85 15 Algeria 5.2 91.6 15 60 27 1.7 0 Andorra 36.5 56.6 3.2 0 1 Angola 12.9 67.0 54 46 8 1 Antigua and Barbuda 29 29 Argentina 6.4 85.2 25 32 8 6 Armenia 8.5 56.8 85 80 33 0.6 0 Australia 29.2 53.4 2 35 13 9.3 0.3 7 Austria 52.4 40.5 26 11 5 2.5 1.5 18 Azerbaijan 4.5 0.01 4 14 14 6.3 0 Bahamas, The 320.6 23.4 55.0 55.0 1 Bahrain 37.8 44.2 52 71 21 27.4 17.3 6 Bangladesh 6.1 66.7 3 3 0 0.9 0.9 1 Barbados 128.4 63.1 100 100 25 3.7 3.7 1 Belarus 3.5 11.0 31 65 45 1 Belgium 81.6 60.2 47 46 4 11.8 0.1 10 Benin 4.7 83.5 98 89 88 Bolivia 1.1 3.0 16 30 30 Bosnia and Herzegovina 42.8 79.8 87 64 18 Botswana 14.7 77.5 78 60 40 7.1 7.1 3 Brazil 18.0 59.9 15 40 3 0.9 0 9 Bulgaria 56.2 83.0 62 65 4 2 Burkina Faso 6.8 79.9 100 100 71 1 Burundi 1.6 0 73 50 25 Cambodia 10.2 68.8 60 61 33 Cameroon 9.0 43.6 76 73 36 Canada 22.5 41.5 3 37 8 21.7 1.2 22 Chile 42.5 74.0 33 41 10 3 China 7.8 37.0 2 20 2 1.3 0.1 12 Colombia 11.7 66.3 15 42 0 0.7 0.6 9 Congo, Dem. Rep. 0.7 25.3 70 83 58 Costa Rica 11.6 60.9 26 21 14 2.9 2.9 1 Croatia 103.8 62.6 90 52 6 1 (appendix continued next page) 138 APPENDIX B GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 TABLE B.1 Foreign Penetration and Internationalization of Financial Systems, 2014 (continued) Foreign bank penetration Internationalization Foreign Foreign Foreign Foreign Foreign developing Foreign developing bank claims bank local bank asset Foreign economy liability economy to GDP claim share share bank share bank share ratio liability ratio Foreign host Economy (%) (%) (%) (%) (%) (%) (%) countries Cuba 1.0 8.7 0 0 0 1 Cyprus 108.0 33.9 12 63 38 0.3 0 5 Czech Republic 83.2 86.3 85 62 10 2 Côte d’Ivoire 11.9 58.9 100 71 36 8.0 8.0 Denmark 79.8 50.5 18 8 0 3.6 0 8 Dominican Republic 6.6 35.3 8 8 3 1 Ecuador 2.7 23.8 12 22 6 7.2 6.2 3 Egypt, Arab Rep. 8.7 84.3 21 54 13 1.7 0.8 4 El Salvador 18.7 82.4 100 91 64 2 Estonia 79.6 92.9 97 75 13 1 Ethiopia 0.7 0 0 0 0 Finland 69.9 53.0 84 22 0 3 France 38.2 13.5 5 4 0 10.0 0.7 46 Gabon 6.9 11.9 1 Gambia, The 12.4 82.8 1 Georgia 6.7 59.5 64 77 38 2 Germany 33.1 38.4 13 14 0 6.7 0.3 32 Ghana 16.0 31.4 69 63 44 6.2 0 Greece 19.9 6.8 0 0 0 14.9 11.7 13 Guatemala 5.5 34.2 30 53 31 14.3 10.1 3 Haiti 4.0 61.8 0 0 0 Honduras 5.2 14.7 53 53 35 2 Hong Kong SAR, China 236.8 78.8 92 73 27 1.8 1.6 1 Hungary 50.0 67.3 56 80 8 10.6 8.9 7 Iceland 33.2 0.1 0 0 0 6.3 0 1 India 12.9 38.9 3 12 0 0.2 0.1 11 Indonesia 12.7 45.6 27 48 9 1.6 1.5 1 Iran, Islamic Rep. 0.2 0.8 0 0 0 0.5 0 5 Iraq 0.3 17.1 1 Ireland 143.1 22.6 36 85 0 20.0 0 2 Israel 4.7 23.0 0 0 0 10.8 0.2 6 Italy 32.2 47.7 6 12 1 16.1 1.1 26 Jamaica 33.5 67.6 91 75 0 2.0 0 1 Japan 15.8 63.3 1 2 0 3.0 0.5 18 Jordan 9.2 19.8 25 40 20 1.0 0 5 GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX B 139 TABLE B.1 Foreign Penetration and Internationalization of Financial Systems, 2014 (continued) Foreign bank penetration Internationalization Foreign Foreign Foreign Foreign Foreign developing Foreign developing bank claims bank local bank asset Foreign economy liability economy to GDP claim share share bank share bank share ratio liability ratio Foreign host Economy (%) (%) (%) (%) (%) (%) (%) countries Kazakhstan 3.1 30.7 13 33 21 0.2 0.2 5 Kenya 10.1 49.0 36 32 18 0.9 0.9 4 Korea, Rep. 20.3 53.8 7 13 0 1.1 0.7 11 Kuwait 8.8 9.5 7 11 0 10.4 7.7 8 Kyrgyz Republic 0.6 0 79 83 80 Latvia 52.8 89.4 58 55 25 3.2 0 2 Lebanon 10.1 24.6 29 36 18 0.9 0.1 10 Libya 0.3 1.4 0 0 0 4.5 1.8 17 Liechtenstein 72.9 0.3 11.1 0 6 Lithuania 53.7 79.1 91 75 0 14.0 0 1 Luxembourg 743.3 12.4 92 95 3 2.0 0 3 Macedonia, FYR 30.1 80.1 68 67 17 Madagascar 11.9 33.0 100 100 50 Malawi 0.9 0 34 25 25 3 Malaysia 50.4 70.3 17 42 9 6 Mali 1.6 37.4 61 67 63 11 Malta 167.3 36.5 1.1 0 1 Mauritania 6.3 0 4 38 25 Mauritius 60.9 34.2 55 60 33 0.9 0.9 6 Mexico 27.7 78.7 70 37 0 0.5 0 4 Moldova 8.6 64.5 27 50 0 Monaco 2.4 0 Mongolia 6.1 0 7 13 13 Montenegro 25.5 37.9 89 88 25 Morocco 28.5 72.3 19 36 0 7 Mozambique 41.0 83.7 94 85 38 Namibia 2.2 0 52 43 43 5.3 5.3 Nepal 1.4 35.9 11 10 7 Netherlands 67.3 16.9 4 47 17 10.9 0.6 24 New Zealand 157.1 94.9 94 78 0 0.2 0 Nicaragua 4.4 48.9 39 60 40 6 Niger 1.2 0 69 71 67 Nigeria 2.7 19.1 19 28 12 3.4 0.6 12 Norway 42.5 56.4 14 2 0 1.6 0 8 Oman 12.8 53.2 11 17 0 2 (appendix continued next page) 140 APPENDIX B GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 TABLE B.1 Foreign Penetration and Internationalization of Financial Systems, 2014 (continued) Foreign bank penetration Internationalization Foreign Foreign Foreign Foreign Foreign developing Foreign developing bank claims bank local bank asset Foreign economy liability economy to GDP claim share share bank share bank share ratio liability ratio Foreign host Economy (%) (%) (%) (%) (%) (%) (%) countries Pakistan 3.5 76.9 52 43 5 1.3 0 5 Panama 83.5 10.2 67 69 54 49.9 49.9 3 Paraguay 9.4 77.2 51 64 36 1 Peru 25.7 75.1 51 69 13 2 Philippines 13.0 38.4 1 12 2 3.2 3.0 2 Poland 51.0 79.8 76 76 0 0.1 0.1 2 Portugal 54.6 63.2 23 36 5 0.9 0.7 11 Qatar 16.6 16.7 0 0 0 1.1 0 5 Romania 44.0 66.9 79 82 4 0.6 0 1 Russian Federation 7.5 38.8 8 17 3 8.0 3.5 24 Rwanda 0.6 0 13 50 50 San Marino 41.7 16.2 1 Saudi Arabia 8.5 7.3 0 0 0 0.04 0.04 3 Senegal 18.8 59.1 94 83 56 Serbia 48.7 77.8 75 66 6 3 Seychelles 106.9 14.5 65 40 20 Singapore 125.1 67.5 6 55 5 8 Slovak Republic 69.5 68.4 75 67 7 17.0 0 1 Slovenia 39.2 65.8 25 35 6 3.1 3.1 4 South Africa 29.3 71.5 23 24 4 2.4 1.9 18 Spain 33.6 27.3 2 13 2 33.4 11.4 21 Sri Lanka 9.4 66.4 0 0 0 Sudan 0.2 0 9 21 21 Swaziland 1.9 2.4 100 60 60 Sweden 23.7 11.4 0 1 0 36.6 0.03 11 Switzerland 47.4 31.4 2 20 5 7.9 1.4 22 Syrian Arab Republic 0.8 2.8 2.6 2.6 1 Tanzania 5.7 68.6 47 67 52 1 Thailand 30.4 78.9 7 25 10 0.4 0.4 4 Togo 12.2 1.8 0 17 17 28.2 28.2 15 Trinidad and Tobago 32.5 82.3 57 75 13 1 Tunisia 15.7 64.5 28 47 29 Turkey 27.6 54.3 14 38 11 4.4 0.1 15 Uganda 6.5 41.1 85 83 67 Ukraine 11.3 69.2 28 39 14 7.4 1.0 4 United Arab Emirates 29.1 51.6 1 22 11 0.4 0.4 7 GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 APPENDIX B 141 TABLE B.1 Foreign Penetration and Internationalization of Financial Systems, 2014 (continued) Foreign bank penetration Internationalization Foreign Foreign Foreign Foreign Foreign developing Foreign developing bank claims bank local bank asset Foreign economy liability economy to GDP claim share share bank share bank share ratio liability ratio Foreign host Economy (%) (%) (%) (%) (%) (%) (%) countries United Kingdom 82.2 64.3 14 58 18 13.8 1.8 55 United States 31.8 61.8 11 31 0 5.1 0.4 62 Uruguay 22.9 82.8 92 78 26 2 Uzbekistan 1.3 0 6 20 13 1 Venezuela, RB 9.9 86.3 18 27 12 3 Vietnam 17.4 48.6 5 23 10 0.1 0.0 1 Yemen, Rep. 2.3 0 0 0 0 Zambia 8.8 62.7 99 94 56 1 Zimbabwe 4.9 27.8 36 38 23 NOTES Additional data: The table above presents holdings of debt securities, equity securities, information from various databases and participations, derivatives instruments with research papers, including the Bank for positive market value, and any other residual International Settlements (BIS) Consolidated on-balance-sheet financial claims. This indi- Banking Statistics (CBS), World Bank Global cator provides an aggregate measure of the Financial Development Database (GFDD), size of foreign bank funding for an economy. Claessens and van Horen (2015), and Bertay, The data are based on BIS CBS table B4 and Demirgüç-Kunt, and Huizinga (2017). World Development Indicators. Period covered : The table shows the most Foreign bank local claims share (%): Share recently available data, up to 2014. of local claims among consolidated foreign bank claims on a counterparty country. Local Economy: A territorial entity for which statis- claims are booked by foreign bank offices tical data are maintained and provided inter- inside counterparty economy and can be in nationally on a separate and independent either local or foreign currency. This indica- basis (not necessarily a state as understood tor provides a measure of the importance of by international law and practice). The term, brick and mortar business by foreign banks used interchangeably with country, does not for an economy, as opposed to its reliance on imply political independence or official rec- cross-border foreign funding. The data are ognition by the World Bank. based on BIS CBS table B4 and World Devel- opment Indicators. Foreign bank claims to GDP (%): Consoli- dated foreign bank claims on a counterparty Foreign bank asset share (%): Percentage of economy. A bank is foreign if it is headquar- the total banking assets that are held by for- tered outside an economy’s jurisdiction. Con- eign banks. A foreign bank is a bank where solidated claims capture worldwide positions a majority its shares are owned by foreign- by bank offices, including foreign subsidiaries ers. This indicator provides a measure of the and branches and excluding inter-office activ- importance of foreign bank assets within an ity. Bank claims include loans and deposits, economy’s banking system. The data are from 142 APPENDIX B GLOBAL FINANCIAL DEVELOPMENT REPORT 2017/2018 the GFDD, using input from Claessens and by the total liabilities of the banking system. van Horen (2015). The values represent 2013. This indicator provides a proxy measure for the extent of internationalization of an econ- Foreign bank share (%): Percentage of the omy’s banking system. The data are com- number of foreign-owned banks to the num- puted by the Global Financial Development ber of the total banks in an economy. A for- Report team as part of Bertay, Demirgüç- eign bank is a bank where a majority of its Kunt, and Huizinga (2017). shares are owned by foreigners. This indica- tor provides a measure of the presence of for- Foreign developing economy liability ratio eign bank offices within an economy’s bank- (%): Percentage of liabilities located in a for- ing system. The data are from the GFDD, eign developing economy by economy’s bank- using input from Claessens and van Horen ing system, calculated by aggregating liabili- (2015). The values represent 2013. ties of majority-owned subsidiaries in foreign developing countries and dividing by the Foreign developing economy bank share (%): total liabilities of the banking system. This Percentage of the number of foreign develop- indicator provides a proxy measure for the ing economy–owned banks to the number extent of internationalization into developing of the total banks in an economy. A foreign countries of economy’s banking system. The bank is a bank where a majority of its shares data are computed by the Global Financial are owned by foreigners. This indicator pro- Development Report team as part of Bertay, vides a measure of the presence of developing Demirgüç-Kunt, and Huizinga (2017). economy banks within a economy’s banking system. 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