| Abstract: |
Several recent studies document that the extent to which banks transmit shocks
across borders depends on the type of foreign activities these banks engage
in. This paper proposes a model to explain the composition of banks’ foreign
activities, distinguishing between international interbank lending, intrabank
lending, and cross-border lending to foreign firms. The model shows that the
different activities are jointly determined and depend on the efficiencies of
countries’ banking sectors, differences in the return on loans across
countries, and impediments to foreign bank operations. Specifically, the model
predicts that international interbank lending increases and lending to foreign
nonbanking firms declines when banks’ barriers to entry rise, a hypothesis
supported by German bank-level data. This result suggests that policies that
restrict the operations of foreign banks in a country may move activity onto
international interbank markets, with the potential to make domestic credit
overall less resilient to financial distress. |