The role of banks as intermediaries in global financial markets continues to evolve as regulatory reform, financial product innovation, and information technology allow them to further broaden the scope of intermediation activity. A popular perception of this process is that banks have become more “globalized,” as witnessed by their ever-increasing operations in foreign jurisdictions. Canadian banks are no exception. At the same time,this perceived rise in the global nature of banks has occurred during a period of increased financial fragility. The 1990s, in particular, witnessed a plenitude of banking, currency, financial, and sovereign debt crises. Naturally, the growing frequency of crises, and the possibility that these crises could lead to contagion through the banking system, have received considerable attention from policy-makers and academics alike.
Despite the growing concern of the effect of financial crises and the possibility of contagion within globally integrated financial markets, little is known regarding the behaviour of Canadian banks’ foreign-asset exposures. Similarly, despite numerous empirical investigations, there is little evidence to support the notion that contagion exists (Karolyi 2003). Although a few studies have explored the potential for contagion and systemic risk in payment systems, the question of how banks’ foreign-asset exposures respond to crisis events remains largely unanswered. The objective of this paper is to address these two issues: first, to what extent have Canadian banks become increasingly globalized; and second, do Canadian banks’ foreign-asset exposures respond to contagious crisis events?
Firm-level panel data on Canadian banks are used to describe the behaviour of the foreign-asset exposures of Canadian banks, and to assess the existence and impact of contagion. This unique Bank of Canada data set extends from 1984 to 2003 on a quarterly basis for a set of Canadian banks with claims in over 150 foreign jurisdictions. Specifically, banks’ foreign asset exposures include loans and deposits to foreign firms, banks, and public sector entities, and holdings of public and private securities. The panel nature of the data permits tests of the existence of information-based contagion and for its possible impact on the foreign-asset portfolios of Canadian banks. Specifically, do banks reduce their foreign claims to countries that appear to be similar to those that have experienced a banking crisis? Preliminary results find that, conditional on fundamentals, banks do not adjust their portfolios immediately in crisis events. Thus, information based contagion plays only a small role in determining the asset portfolios of banks.
The paper will proceed as follows. Section 1 reviews the literature on the foreign-asset exposure of Canadian banks and the empirical literature on banking crises and contagion. Section 2 offers a theoretical framework for assessing the behaviour of banks during crisis episodes, while section 3 presents the empirical model. Section 4 describes the data, and section 5 presents descriptive statistics. Section 6 offers regression results of the effect of banking crises on the behaviour of Canadian banks’ foreign-asset exposures. The final section concludes and offers avenues for future research.
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