International Bank Flows and the Global Financial Cycle

Abstract

What is the role for supply and demand forces in determining movements in international banking flows? And what role might a common factor—the global financial cycle highlighted by Rey (Dilemma not trilemma: the global financial cycle and monetary policy independence, 2018) and others—play in movements in these flows? Answering these questions is crucial for understanding the international transmission of financial shocks and formulating policy. This paper addresses them by using the method developed in Amiti and Weinstein (J Polit Econ 126(2):525–587, 2018) to exactly decompose the growth in international bank credit into common shocks, idiosyncratic supply shocks and idiosyncratic demand shocks for the period 2000–2017. A striking feature of the global banking flows data can be characterized by what we term the “Anna Karenina Principle”: all healthy credit relationships are alike, and each unhealthy credit relationship is unhealthy in its own way. During non-crisis years, bank flows are well explained by a common global factor. But during times of crisis, flows are affected by idiosyncratic demand shocks to borrower countries and by supply shocks to their creditor banks. That is, the importance of the common component seems to vary over time. This has important implications for why standard econometric models break down during crises.

Appendices

Appendix 1: Deriving the common shock

Amiti and Weinstein (2018) show in Proposition 4 that one can obtain estimates of C country borrower and B banking-system shocks that satisfy

$$D_{jt}^{B} \equiv \frac{{\mathop \sum \nolimits_{i} L_{ijt} - \mathop \sum \nolimits_{i} L_{ij,t - 1} }}{{\mathop \sum \nolimits_{i} L_{fb,t - 1} }} = \beta_{jt} + \sum_{i} \emptyset_{ij,t - 1} \alpha_{it}$$

(A1)

$$D_{jt}^{C} \equiv \frac{{\mathop \sum \nolimits_{j} L_{ijt} - \mathop \sum \nolimits_{j} L_{ij,t - 1} }}{{\mathop \sum \nolimits_{j} L_{fb,t - 1} }} = \alpha_{it} + \sum_{j} \theta_{ij,t - 1} \beta_{jt}$$

(A2)

This can be written more compactly as:

$$\varvec{D}_{t}^{B} = \varvec{B}_{t} + {\varvec{\Phi}}_{t - 1} \varvec{A}_{t}$$

(A3)

and

$$\varvec{D}_{t}^{C} = \varvec{A}_{t} + {\varvec{\Theta}}_{t - 1} \varvec{B}_{t}$$

(A4)

where

$$\varvec{A}_{t} \equiv \left[ {\begin{array}{*{20}c} 0 \\ {\alpha_{2t} } \\ {\begin{array}{*{20}c} \vdots \\ {\alpha_{ct} } \\ \end{array} } \\ \end{array} } \right] \quad {\text{and}}\quad \varvec{B}_{t} \equiv \left[ {\begin{array}{*{20}c} {\beta_{1t} } \\ {\beta_{2t} } \\ {\begin{array}{*{20}c} \vdots \\ {\beta_{Bt} } \\ \end{array} } \\ \end{array} } \right]$$

and

$$\varvec{D}_{t}^{C} \equiv \left[ {\begin{array}{*{20}c} {D_{1t}^{C} } \\ \vdots \\ {D_{Ct}^{C} } \\ \end{array} } \right],\,\varvec{D}_{t}^{B} \equiv \left[ {\begin{array}{*{20}c} {D_{1t}^{B} } \\ \vdots \\ {D_{Bt}^{B} } \\ \end{array} } \right],\,{\varvec{\Theta}}_{t} \equiv \left[ {\begin{array}{*{20}c} {\theta_{11t} } & \cdots & {\theta_{1Bt} } \\ \vdots & \ddots & \vdots \\ {\theta_{C1t} } & \cdots & {\theta_{CBt} } \\ \end{array} } \right],\,{\varvec{\Phi}}_{t} \equiv \left[ {\begin{array}{*{20}c} {\emptyset_{11t} } & \cdots & {\emptyset_{C1t} } \\ \vdots & \ddots & \vdots \\ {\emptyset_{1Bt} } & \cdots & {\emptyset_{CBt} } \\ \end{array} } \right]$$

and the parameter estimates that would solve this new system. We can renormalize the system by expressing each shock relative to the median borrowing-country or banking-system shock. Specifically, we define the common borrower shock, $\varvec{ }\bar{A}_{t}$, as the median borrower shock, and the common banking-system shock as the median banking-system shock, $\varvec{ }\bar{B}_{t}$. We next define the borrowing-country shock as the difference between the actual shocks and the median shock, i.e. $\dot{\varvec{A}}_{\varvec{t}} \equiv \varvec{A}_{t} - \bar{A}_{t} 1_{C}$ and $\dot{\varvec{B}}_{\varvec{t}} \equiv \varvec{B}_{t} - \bar{B}_{t} 1_{B}$. We can rewrite the system of equations as

$$\varvec{D}_{t}^{C} = \varvec{A}_{t} + {\varvec{\Theta}}_{t - 1} \varvec{B}_{t} = \dot{\varvec{A}}_{\varvec{t}} + \bar{A}_{t} 1_{C} + {\varvec{\Theta}}_{t - 1} \dot{\varvec{B}}_{\varvec{t}} + \bar{B}_{t} {\varvec{\Theta}}_{t - 1} 1_{B} = \left( {\varvec{ }\bar{A}_{t} + \varvec{ }\bar{B}_{t} } \right)1_{C} + \dot{\varvec{A}}_{\varvec{t}} + {\varvec{\Theta}}_{t - 1} \dot{\varvec{B}}_{\varvec{t}} = \hat{c}_{t} 1_{C} + \dot{\varvec{A}}_{\varvec{t}} + {\varvec{\Theta}}_{t - 1} \dot{\varvec{B}}_{\varvec{t}}$$

where we move from the second line to the third line by making use of the fact that the borrowing shares from each financial institution (${\varvec{\Theta}}_{t - 1}$) must sum to one, i.e. ${\varvec{\Theta}}_{t - 1} 1_{B} = 1_{C}$ and define the common shock to be $\hat{c}_{t} \equiv \varvec{ }\bar{A}_{t} + \varvec{ }\bar{B}_{t}$. Just as we can decompose firm borrowing into these three shocks, we can also decompose bank lending into a similar set of three elements. Similarly, we can rewrite Eq. (A1) as

$$\varvec{D}_{t}^{B} = \dot{\varvec{B}}_{\varvec{t}} + {\varvec{\Phi}}_{t - 1} \dot{\varvec{A}}_{\varvec{t}} + \left( {\varvec{ }\bar{B}_{t} 1_{B} + \varvec{ }\bar{A}_{t} {\varvec{\Phi}}_{t - 1} 1_{C} } \right) = \left( {\varvec{ }\bar{A}_{t} + \varvec{ }\bar{B}_{t} } \right)1_{B} + \dot{\varvec{B}}_{\varvec{t}} + {\varvec{\Phi}}_{t - 1} \dot{\varvec{A}}_{\varvec{t}} = \hat{c}_{t} 1_{C} + \dot{\varvec{B}}_{\varvec{t}} + {\varvec{\Phi}}_{t - 1} \dot{\varvec{A}}_{\varvec{t}}$$

Appendix 2: Adjustments to Foreign Claims

2.1 Breaks-in-Series

Breaks-in-series caused, for example, by bank mergers or methodological changes lead to jumps in bilateral positions that do not signify that extension or withdrawal of actual credit. Fortunately, the distortions caused by many of the largest of the breaks can be corrected. Reporting countries often provide to the BIS, on a confidential basis, “pre-break” values of outstanding claims from which adjusted bilateral growth rates can be constructed. Where available, we have used these pre-break values in calculating the year-over-year changes in outstanding bilateral claims amounts, which are used as inputs in the empirical analysis.

When there is a known break-in-series, but the pre-break data are not available (i.e. not provided by the reporting jurisdiction), we have two choices: either truncate the sample for the affected banking system, so that the series starts in the quarter after the break; or assume the pre-break growth rates are zero. A priori, it is not clear which procedure is better. Truncating the series has no effect on the estimated shocks in later periods. But the aggregate growth rates (and hence the estimated common and demand-side shocks) prior to the break date are necessarily affected since some observations have been excluded. By the same token, retaining the full series for these banking systems and simply assuming that the growth in claims in the quarter in which the break occurred is zero also introduces error into the estimated shocks. In practice, however, the difference between these approaches is small. In what is presented in the paper, we have truncated the series for certain banking systems where breaks occurred.

For one observation for which break-in-series values were not available, we estimated the break value from information in the underlying bilateral positions. For another that reflected the purchase of a subsidiary bank in a particular country, we assumed that the break value was simply full change in the outstanding claim amount.

2.2 Exchange Rate Movements

Foreign claims on a particular borrower country tend to be denominated in a mixture of currencies. Changes in the relative value of these currencies induce changes in the outstanding stock of claims when expressed in any single currency, here in US dollars. Changes in exchange rates may have economic meaning from the perspective of a reporting banking system, for example in analyses of how currency mismatches across the balance sheet affect bank profitability. However, they are not indicative of the provision or retraction of actual credit, which is the metric needed for the empirical analysis in this paper. In most quarters, exchange rate movements contribute little to the growth in aggregate foreign claims. But, as shown in the main text, extreme exchange rate movements, like those that occurred in the months following the collapse of Lehman Brothers, significantly distort measures of the growth in foreign claims.

The first step in the adjustment is to obtain measures of the share of each currency in foreign claims. Foreign claims can be broken into three pieces: (a) cross-border claims (XBC), (b) local claims in foreign (i.e. non-local) currencies (LCFC) and (c) local claims in local currencies (LCLC). That is, FC = XBC + LCFC + LCLC. In the CBS, XBC and LCFC are reported together as international claims (INTLC = XBC + LCFC), although these claims can be separated (albeit imperfectly) using the BIS Locational Banking Statistics, which has a currency breakdown. We obtain the currency shares for each of these three components separately and then use them to obtain the shares of each currency in total foreign claims.

The currency shares for these three pieces are obtained as follows:

(a) LCLC: The currency of denomination of LCLC is known by construction. It is simply the currency in use in the borrower country.

(b) LCFC: For many banking-system borrower pairs, the currency shares for LCFC are also known, from the BIS Locational Banking Statistics by Nationality (LBSN). Unlike the CBS, the LBSN track the cross-border claims and local claims in non-local currencies (LCFC) of banks located in a particular location, broken down by the nationality of the banking system.³⁷ Thus, for any country that reports the LBSN to the BIS, we know the currency breakdown (USD, EUR, JPY and other foreign currencies) for each national banking systems’ LCFC on the residents of that reporting country.

Currently, more than 40 countries report the LBSN to the BIS, covering more than 95% of each consolidated national banking systems’ global foreign claims. But there are only a few emerging economies that report the LBSN (Brazil, Chile Mexico, South Africa, Chinese Taipei, India, Indonesia, Malaysia and South Korea), and several of them only started reporting after 2000. We do not have actual data about the currency composition of each banking systems’ LCFC vis-à-vis those countries that do not report in the LBSN (e.g. China, Czech Republic, Hungary and Poland). For these countries, we assume that the composition of each banking systems’ LCFC is the same as that for all cross-border claims on that country, as described in (c) below.³⁸

(c) XBC: Obtaining the currency shares for a consolidated national banking system’s cross-border claims on a particular country is the most problematic. The LBSN provide information about the currency composition of banks’ cross-border claims booked by their offices in each reporting location. But, critically, they do not reveal the location (country) of the borrower.³⁹ The BIS Locational Statistics by Residency (LBSR), by contrast, track the cross-border claims booked by banks offices in each reporting country on individual borrower countries, broken down by currency. But, the LBSR, unlike the LBSN, do not reveal the nationality of the banking system located in each reporting country. In addition, cross-border claims in the LBSR include banks’ interoffice positions, which are not included in the CBS and thus not in foreign claims. Cross-border claims in the LBSR are broken down into positions denominated in USD, EUR, JPY, GBP, CHF, the domestic currency of the borrower country, and “Other” foreign currencies.

To obtain the currency shares of each national banking system’s worldwide consolidated cross-border claims on a particular country, we take the shares reported in the LBSR for banks of all nationalities and apply these to banks of each nationality. That is, the currency shares of US banks’ cross-border claims on Hungary are assumed to be the same as the shares of German, Swiss and other banks’ claims on Hungary. For those borrower countries that themselves report the LBSN to the BIS, we make an additional correction to exclude interoffice positions in each currency. Specifically, for these countries, we obtain the currency distribution by taking cross-border claims of all banks in all other BIS reporting countries on all sectors in the borrower country and subtract from this the total cross-border interoffice liabilities reported by banks (of all nationalities) located in the borrower country.

For those borrower countries that do not report the LBSN, we assume that the currency composition of the total international claims in the CBS (INTLC = XBC + LCFC) is simply equal to the currency composition of total cross-border claims (including interoffice) from the LBSR.

With the currency shares for the three components of foreign claims in hand, we are able to estimate the overall currency shares for each consolidated banking system’s total foreign claims on each borrower country. The second step in our adjustment is to feed these data series, along with exchange rates, into a chain-linked adjustment that yields the year-over-year growth in foreign claims excluding the effect of exchange rate movements.

Appendix 3: Estimated shocks and the maturity of claims

The estimated supply and demand shocks are heterogeneous across borrower countries. One reason for this is that foreign claims differ across countries in terms of the counterparty sector, maturity and instrument, all of which affect the ease with which creditor banks can adjust their balance sheets. For example, banks can more quickly cut back on short-term interbank loans by simply not rolling them over. Similarly, they can quickly sell high-quality liquid securities. But longer-term loans and illiquid securities are far more difficult to take off the balance sheet.

Estimation of the shocks based on bilateral foreign claims does not take these claim characteristics into account. Yet the combination of instrument, maturity and counterparty type for a particular borrower country clearly has an impact on the estimated shocks, as discussed in Sect. 5.4.2. Borrower countries where a high share of the claims in 2007 was short-term or interbank experienced larger contractions in the growth of overall foreign claims. These outsized contractions mean that the common shock accounts for less of the overall change in the growth rate, leaving the estimated demand and supply-side shocks to absorb the remaining part. This has bearing on how the estimated shocks should be interpreted, as discussed below.

Table 4 provides some concrete examples of where these differences come into play. Column 2 lists all banks’ combined foreign claims at end-Q2 2007 on the country listed in the first column. The breakdown by remaining maturity is available only for international claims (column 3); no such information is available for banks’ local claims in local currencies. As such, short-term international claims (column 4) provide a lower-bound estimate of the share of short-term claims in total foreign claims (column 5). More than 80% of the claims on China were international claims (column 5), meaning banks’ had a relatively small local presence there. And more than half of these had a remaining maturity of one year or less (column 7). As a result, short-term claims comprised at least 44% of the total foreign claims on China (column 6), and the highest share for all the countries is listed in Table 4. Only claims on Caribbean offshore centres, virtually all of which were international, had an estimated share close to China’s (39%). By contrast, the estimated shares for Latin America (15%) and Emerging Europe (24%) were considerably lower. These differences across regions help explain the heterogeneous growth in foreign claims in Fig. 3 in the main text.

Table 4 Characteristics of claims on selected borrower countries.

These differences have implications for the interpretation of the shocks. To see this, the left panel of Fig. 13 shows a comparison of the common shock estimated for foreign claims (red line) and for short-term international claims only (gold line). Focusing only on short-term claims greatly reduces the outstanding claim amounts, but also reduces the heterogeneity across countries in the flexibility of the claims. With this heterogeneity removed, the dynamics of short-term claims are more likely to be driven by common shocks than by idiosyncratic supply and demand shocks. During the 2007–2009 crisis period, this indeed seemed to be the case: the common shock estimated with short-term claims moved farther into negative territory (− 10%) than that estimated with foreign claims.

Fig. 13

Sources: BIS consolidated banking statistics (IC basis); BIS locational banking statistics; national data; authors’ calculations

Shock estimates for foreign claims and short-term international claims. Notes: The solid vertical lines indicate the crisis window (end-Q2 2007 to end-Q4 2009). The dashed vertical line indicates end-Q3 2008, just after the collapse of Lehman Brothers. ¹The lines show the estimated common shock based on the year-over-year growth in foreign claims (FC, red line) and in short-term international claims only (ST INTL, gold line). ²Shock estimates based on the year-over-year growth in ST INTL.

That said, for individual countries, the broad patterns in the demand shocks evident in the figures in the main text are not all that different when estimated with short-term international claims only. The centre and right panels of Fig. 13 show the complete set of estimated shocks for China and Hungary. A comparison of these panels to their counterparts in Fig. 11 shows that short-term claims contracted more (black lines) during the 2007–2009 financial crisis (for China) and during the European sovereign crisis (for Hungary) than did foreign claims. However, the overall patterns are remarkably similar, which suggests that the demand shocks we estimate pick up the movements in short-term claims.

Appendix 4: Estimated Shocks for Additional Banking Systems

Fig. 14

Source: BIS consolidated banking statistics (IC basis); BIS locational banking statistics; national data; authors’ calculations

Shocks to selected banking systems. Notes: The solid vertical lines indicate the crisis window (end-Q2 2007 to end-Q4 2009). The dashed vertical line indicates end-Q3 2008, just after the collapse of Lehman Brothers. ¹Year-on-year growth in foreign claims of internationally active banks of the nationality indicated in the panel title, adjusted for breaks-in-series and exchange rate movements. ²Estimated net demand shocks to the borrower countries on which the banking system in the panel title has outstanding foreign claims. ³Estimated supply shocks that are unique to banking system in the panel title. ⁴Estimated shocks that are common to all banking systems and borrower countries.