Lending by foreign banks to emerging markets is a defining feature of financial globalization. In the years preceding the recent global crisis, foreign bank lending to emerging economies expanded rapidly—whether directly from foreign banks‘ headquarters (cross border) or through affiliates operating in host countries. Although it had its pros and cons, on balance the presence of foreign-owned banks was generally believed to have enhanced competition and aided overall financial stability.
During the recent global credit crunch, however, foreign banks were potential vehicles for spreading a crisis that originated in advanced economies into emerging markets. As their financial health deteriorated sharply, banks‘ global scramble for dollar liquidity and the need to deleverage balance sheets raised concerns that these bank flows could retrench significantly, disrupting macroeconomic stability in emerging markets.
For many Latin America and Caribbean (LAC) countries, the onset of the global credit crunch was a potentially crucial development. Over the previous five years, lending by foreign banks had become a significant source of funding for households and corporations in many economies of the region. Understanding how the global financial shock has been transmitted to LAC through the foreign bank-lending channel is therefore of policy interest not only for those countries that already rely heavily on foreign banks, but also for those that may be thinking of opening up their markets to foreign banks‘ operations.
In this paper, we undertake an econometric analysis of the determinants of foreign banks‘ lending to the LAC region between the last quarter of 1999 and the fourth quarter of 2008. We assess the effects of three key factors that have shaped the recent global financial turmoil—tight inter-bank liquidity, mounting pressure on major banks‘ capital positions in advanced economies and more restrictive lending standards in developed countries‘ banking systems.
Our results indicate that, on average, international money market conditions have a significant impact on foreign banks‘ lending to Latin America and the Caribbean. In particular, funding pressure caused by liquidity shortages in the global inter-bank market adversely affects foreign banks‘ lending growth to the region. Also, a deterioration of parent banks‘ own financial soundness in advanced economies leads to reductions in their financing to the LAC region. Changes in banks‘ lending standards in advanced economies also seem to have a statistically significant effect on the growth of foreign banks‘ credit to Latin America. Yet crucially, our results also indicate that the propagation of these global financial shocks is significantly more muted for countries where foreign banks conduct a higher share of their lending in domestic currency.
Contents
I. Introduction
II. Data and Stylized Facts for Latin America
- A. BIS Data
B. Key Features of Foreign Banks‘ Involvement in LAC
III. Empirical Strategy
IV. Main Econometric Results
V. Was There a Retrenchment Post-Lehman? Latest Cross-Regional Evidence
VI. Interpreting the Evidence
VII. Conclusion
