Foreign Banks: Not So Bad After All?

Late last year the Commission on Growth and Development came out with an influential paper reviewing the case for openness to international finance. The paper - titled International Finance and Growth in Developing Countries: What Have We Learned? - concluded that there was at best ambiguous evidence of the benefit of openness to international finance:

Despite an abundance of cross‐section, panel, and event studies, there is strikingly little convincing documentation of direct positive impacts of financial opening on the economic welfare levels or growth rates of developing countries...There is also little systematic evidence that financial opening raises welfare indirectly by promoting collateral reforms of economic institutions or policies. At the same time, opening the financial account does appear to raise the frequency and severity of economic crises.

The lesson would seem to be that developing countries ought to be wary of inviting in foreign sources of finance. However, a new column in VoxEU by Ralph de Haas, a senior economist at EBRD, at least partially contradicts this notion. de Haas argues that foreign subsidiaries of banks (although not necessarily cross-border lending) are typically a stabilizing influence:

In a forthcoming article, Iman van Lelyveld and I analyse a large bank-level dataset of foreign bank subsidiaries across the world to compare lending by foreign bank subsidiaries with lending by domestic banks...

...We find that subsidiaries of stronger parent banks – with high net interest margins or low loan loss provisioning – grow faster and that parent banks trade off lending across countries. Importantly, as a result of parental support, foreign bank subsidiaries do not typically rein in their lending during a financial crisis. In sharp contrast, we find that domestic bank lending decreases substantially during local banking crises. Apparently, subsidiaries can rely on parental support during a financial crisis, a form of support that is not available to domestic banks. This finding confirms similar results reported by De Haas and Van Lelyveld (2006) for a sample of transition countries.

These findings imply that, across the board, openness to multinational bank subsidiaries may actually benefit host countries. Multinational banks provide a stabilising factor during local financial turmoil in particular.