Do Foreign Banks Stabilize Cross-Border Bank Flows and Domestic Lending in Emerging Markets? Evidence from the Global Financial Crisis

Abstract

Does a strong presence of foreign banks amplify or mitigate sudden stops of cross-border bank flows to emerging market economies (EMEs)?¹ Do foreign banks reduce or aggravate the associated decline in bank lending in the respective host countries? The global financial crisis provides a unique opportunity to examine these questions. This is because the pre-crisis years were characterized by substantial cross-border bank flows and rapid credit growth in EMEs. In addition, foreign banks became important players in many EME banking sectors, with the average share of assets held by foreign banks in host country banking sectors rising from 21% in 1995 to 38% in 2005 (Claessens et al., 2008). However, in the ‘acute phase’ (Blanchard et al., 2010) of the global financial crisis, that is, the fourth quarter of 2008 and the first quarter of 2009, EMEs faced a classical sudden stop, which is defined as a large and unexpected fall in capital inflows. Following patterns observed in the past (Mendoza and Terrones, 2008), the bust in cross-border flows was associated with a corresponding contraction of domestic lending.