Abstract
The paper examines the determinants of cross-border interbank and intragroup funding across crisis and noncrisis periods. Using a previously unexplored data set spanning 25 banking systems, it finds that aggregate intragroup funding is unrelated to fluctuations in either global or local macroeconomic fluctuations, while flightier interbank funding responds procyclically to both worldwide and domestic economic trends. This feature of the data means intragroup funding remains comparatively stable when global conditions deteriorate—even during the global financial crisis. During “normal” times the paper finds that intragroup funding responds countercyclically to global interest rate changes, with parent banks using affiliates to offset tighter global funding conditions. More generally, it finds that intragroup funding has a closer relationship with domestic banking system profitability and solvency, being used to support banks in weaker banking systems during the global financial crisis.
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Notes
One study to also directly investigate intragroup flows across multiple countries is by Allen, Gu, and Kowalewski (2013). The authors hand-collect data on intragroup transactions from the financial statements of European Union banks between 2007 and 2009. The main purpose of this study, however, is to evaluate the European Union’s regulatory structure regarding internal capital market flows and evaluate its appropriateness in light of the transactions uncovered within the study. The main finding is that intragroup transactions could be significantly detrimental to a foreign affiliate to the extent that a country’s financial stability could be affected.
The results of our paper indicate that a fruitful area for future theoretical and empirical work could explore why global banks adopt one type of cross-border funding structure over another and whether a possible optimal combination exists that maximizes firm value. Kerl and Niepmann (2014) make a recent theoretical contribution in this direction, finding that a bank’s composition of interbank relative to intragroup lending is driven by the efficiency of the banking system, the return to capital and entry barriers which impede foreign bank operations. From an empirical perspective, De Haas and Kirschenmann (2013) investigate the determinants of internal capital market characteristics. Interviewing the CEOs of over 400 banks from emerging Europe, the authors find parent- and host-country characteristics are stronger determinants of the intragroup structure than either parent or foreign affiliate bank characteristics.
See Goldberg and Gupta (2013) and Carney (2013) for recent discussions and the Federal Reserve Board (2014) for a description of the recently finalized rules that require large foreign affiliates operating in the United States to adhere to U.S. capital and liquidity rules.
Although the BIS makes some international banking data publicly available, due to confidentiality, the split between interbank and intragroup funding is part of a nonpublic restricted data set.
While we exclude offshore banking centers, note that the funding from offshore banking centers to the 25 banking systems in our study is included. We choose not to study the funding to offshore banking centers for three reasons. First, our primary interest is the impact cross-border flows may have on domestic financial stability, independent of whether these flows were intermediated by offshore centers. Second, only sparse interbank and intragroup data are available for offshore centers. Specifically, only the Cayman Islands, Macao, Panama, and Bermuda report such data, while there are no data for Hong Kong, Singapore, Guernsey, or Jersey. Third, in our empirical setup, we choose to control for country and banking system characteristics. These data are only sparsely available for offshore banking systems, particularly for the few offshore centers which report data on the split between interbank and intragroup funding. Note also, that apart from excluding countries which do not report both interbank and intragroup flow data, we also exclude Finland as it only reports intragroup flows from 2010:Q2 onward.
Owing to data confidentiality, we are unable to report specific country details on intragroup funding and hence, for the purposes of the figure, we anonymize countries.
The countries k=26, 27, …, K do not report banking statistics to the BIS but have resident global banks with operations abroad (significant examples include China and Russia).
The numbers reflect the median change in interbank and intragroup funding across all 25 banking systems in the study. To calculate the change, we sum across flows (adjusted for exchange rate fluctuations) and divide by the stock of funding at the start of the crisis.
More precisely, we measure realized volatility as the square-root of average squared daily returns to the MSCI Global Equity Index, a composite measure of returns across 23 developed market stock indices.
It is not known, however, if flows to a foreign affiliate are directly from the parent bank or from another foreign affiliate located outside the country. The BIS is currently expanding its data set to include bilateral interbank and intragroup flows (Committee on the Global Financial System, 2012), which will help provide further details on the dynamics of internal capital market funding.
We estimate a Hausman test and find that the null hypothesis (the random-effects estimator is consistent) is strongly rejected, indicating the appropriateness of a fixed-effects model.
We examine the impact of two-way clustering in Section III.
The measure provides a broad empirical proxy of global economic uncertainty, providing a more precise measure of “global” uncertainty than the alternative U.S.-centric VIX index of implied U.S. stock market volatility.
Given the natural link between short-term money market rates and broad money growth, changes in interest rates may capture fluctuations in global liquidity which have been linked with bank runs (Giannetti, 2007) and changes in global bank leverage (Brunnermeier, 2009).
Parent banks may purposefully adopt a countercyclical intragroup funding strategy to offset, for example, monetary policy shocks (Jeon and Wu, 2014) or the negative liquidity shock associated with a credit rating downgrade (Karam and others, 2014). De Haas and Van Lelyveld (2014) find parent banks provided less support to their foreign affiliates during the GFC implying that intragroup funding may also contribute to the international propagation of financial shocks, while Popov and Udell (2012) find that foreign affiliates whose parents had low equity ratios or suffered large financial asset losses, reduced their domestic credit expansion by more during the GFC. Cetorelli and Goldberg (2012b) also find the business purpose of the foreign affiliate is important. Specifically, during the 2008–09 crisis, U.S. global banks reallocated intragroup funding back to the United States according to an organizational pecking order: traditional funding locations were used more actively to buffer the domestic liquidity shock, while foreign affiliates viewed as key revenue generators were largely shielded from providing liquidity support.
The figure is based on all foreign and domestic banks in an economy using data from Bankscope. Although Bankscope data are comprehensive, it does not take into consideration the return on equity of foreign branches.
De Haas and Van Horen (2013) also find that parent banks were more likely to maintain intragroup funding during the global financial crisis to affiliates in countries closest to the parent bank’s headquarters.
Note that while ROE and the net interest margin are both linked to performance and profitability, they are not by definition highly correlated. A banking system with a high average ROE, for example, may also be highly leveraged, which amplifies even a small net interest margin and hence the two findings are not incompatible. A possible concern associated with the high correlation between the net interest margin and solvency is that the estimated coefficients are distorted by multicollinearity. To mitigate this concern, we remove the net interest margin and find the ROE and solvency coefficients remain qualitatively unchanged. These additional results are not reported in the interest of space but are available on request.
Note that the study investigates individual banks rather than aggregate banking system data as is done in this study. Moreover, the study excludes foreign branches, whereas we include data on all affiliates, including both foreign subsidiaries as well as foreign branches.
The results presented in this section are also economically significant: a one standard deviation rise in the MSCI index of 0.43 reduces interbank funding growth by 1.52 percentage points (pp) (it rose by around 2 standard deviations following Lehman Brothers’ collapse); and a level of the MSCI index of 53 in 2008:Q3 implies 8pp lower interbank funding growth compared with the calmest periods in the sample. A tightening in global interest rates of 50 basis points reduces interbank funding growth by 2.6pp but increases intragroup funding growth by 2.2 percent. Finally, a one standard deviation rise of around 10pp in a banking system’s return on equity is associated with 1pp higher interbank funding growth and 1.7pp higher intragroup funding growth.
Specifically, in the second specification we remove the period from 2008:Q4 to 2009:Q2 to coincide with the large drop in cross-border bank-to-bank funding documented in Figure 2 that followed the collapse of Lehman Brothers. In the third specification, we remove the period from 2008:Q4 to the end of our sample in 2011:Q4.
The result supports a recent finding by Hoggarth, Hooley, and Korniyenko (2013), who show that gross cross-border intragroup lending by foreign affiliates, resident in the United Kingdom, increased strongly following the run on the British bank, Northern Rock. Notably, the result is driven by the intragroup lending of foreign branches. The gross lending by foreign subsidiaries remained unchanged.
Although not the focus of our paper, in Table A3 we present results on the behavior of interbank funding growth to parent and affiliate banks. Global factors matter for both sets of banks, but we find that global volatility and changes in global interest rates have a stronger impact on parent banks, whereas global growth seems to be the dominant driver of interbank funding to affiliates. We also find evidence that interbank funding to affiliates is more strongly associated with domestic macroeconomic cycles than parent funding, while the opposite is the case for the average profitability of the banking system as a whole.
Recent papers which use the VIX index as a measure of global risk include, inter alia, Longstaff and others (2011), Bacchetta and Van Wincoop (2013), Forbes and Warnock (2012a), and Fratzscher (2012).
Results for including fixed effects are similar but significant only at the 10 percent level. Because most instances of liquidity support occurred during the GFC, we think it is more instructive to also exploit the cross-sectional variation in the size of liquidity support. See Table A6 for further discussion on the effect of excluding fixed effects.
Our regressions account for the health of a country’s banking system. However, one important caveat of including liquidity support is that more liquidity support could be a measure of how intense the banking crisis had been, making it hard to estimate its overall effect. Definitive answers on the impact of liquidity support on interbank and intragroup funding are thus beyond the scope of this paper, most likely requiring micro-banking data such as in Drechsler and others (2014) to provider crisper answers.
As many countries started to report their data only later to the BIS, the sample starting from 1985:Q1 is less balanced than for baseline sample.
The covariance matrix was adjusted using the procedure proposed by Cameron, Gelbach, and Miller (2011).
We have also explored the robustness of our main results to increasing the level of winsorization to 5 percent and find that large observations do not drive any of the key results. We omit these results in the interest of space but they are available upon request.
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Additional information
*Dennis Reinhardt is an Economist in the International Directorate of the Bank of England. He received his Ph.D. in Economics from the Graduate Institute of International and Development Studies, Geneva. Steven Riddiough is at the Department of Finance of the University of Melbourne. He received his Ph.D. in Finance from the University of Warwick in 2014. His paper “Currency Premia and Global Imbalances” won the Kepos Capital Award for the Best Paper on Investments at the 2013 WFA Annual Meeting. The authors are grateful for comments and suggestions to Pierre-Olivier Gourinchas (Editor), two anonymous referees, David Barr, Martin Brooke, Charles Calomiris, Eugenio Cerutti, Pasquale Della Corte, Glenn Hoggarth, Iman van Lelyveld, Friederike Niepmann, Jonathan Newton, Katheryn Russ, Lucio Sarno, Filip Žikeš as well as seminar participants at the Bank of England, the ECB, the 2014 European Economic Association Annual Congress, the 2014 World Congress of the IEA and the DNB/IMF Conference on “International Banking: Microfoundations and Macroeconomic Implications.” They also thank Boris Butt and George Gale for excellent research assistance and David Osborn for answering many data-related questions.
An erratum to this article is available at http://dx.doi.org/10.1057/s41308-017-0034-4.
Electronic supplementary material
Appendix
Appendix
See Tables A1, A2, A3, A4, A5 and A6.
