nep-ifn New Economics Papers
on International Finance
Issue of 2016‒09‒04
six papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. How Do Liquidity Conditions Affect U.S. Bank Lending? By Ricardo Correa; Tara Rice; Linda S. Goldberg
  2. Dynamic Leverage Asset Pricing By Adrian, Tobias; Moench, Emanuel; Shin, Hyun Song
  3. Crises and rescues: liquidity transmission through international banks By Claudia Buch; Catherine Koch; Michael Koetter
  4. Can Countries Rely on Foreign Saving for Investment and Economic Development? By Cavallo, Eduardo; Eichengreen, Barry; Panizza, Ugo
  5. Multinational Firms and International Business Cycle Transmission By Cravino, Javier; Levchenko, Andrei A.
  6. The effect of foreign institutional ownership on corporate tax avoidance: international evidence By Hasan, Iftekhar; Kim, Incheol; Teng, Haimeng; Wu, Qiang

  1. By: Ricardo Correa; Tara Rice; Linda S. Goldberg
    Abstract: October 15, 2014{{p}}How Do Liquidity Conditions Affect U.S. Bank Lending?{{p}}{{p}}Ricardo Correa, Linda Goldberg Leaving the Board, and Tara Rice{{p}}{{p}}The recent financial crisis underscored the importance of understanding how liquidity conditions for banks (or other financial institutions) influence the banks' lending to domestic and foreign customers. Our recent research Leaving the Board examines the domestic and international lending responses to liquidity risks across different types of large U.S. banks before, during, and after the global financial crisis. The analysis compares large global U.S. banks--that is, those that have offices in foreign countries and are able to move liquidity from affiliates across borders--with large domestic U.S. banks, which have to rely on financing raised in capital markets and from depositors to extend credit and issue loans. One key result of our study, detailed below, is that the internal liquidity management by global banks has, on average, mitigated the effects of aggregate liquidity shocks on domestic lending by these banks.{{p}}{{p}}Possible Bank Responses to Liquidity Risks{{p}}Large U.S.-based banks can react to aggregate liquidity shocks by adjusting their domestic lending, their cross-border lending (for example, interbank loans or claims on other counterparties), or their internal lending and borrowing (with affiliates), or potentially make other balance sheet adjustments. The reaction to aggregate liquidity conditions could depend, importantly, on the composition and strength of each bank's balance sheet. For example, if a bank has stable deposit funding or maintains more liquid assets on its balance sheet, its lending might be less affected by aggregate liquidity shocks.{{p}}{{p}}There also might be different responses to liquidity risk by U.S. banks that are domestically oriented compared with banks that are more global Leaving the Board. Because these two types of banks have very different business models, the channels and magnitude of transmission of liquidity risks into bank lending may differ significantly. Small domestic banks have relatively strong lending responses to liquidity risks (Kashyap and Stein [2000] Leaving the Board); Cornett, McNutt, Strahan, and Tehranian [2011]). By contrast, banks with foreign affiliates, particularly large banks, actively move funds across their organizations to offset such risks, and potentially insulate lending in their home markets (Cetorelli and Goldberg 2012). However, these same banks may decrease lending abroad as they move liquidity into their home country. For both types of banks, changes in aggregate private liquidity are likely to influence lending differently in crisis than in normal periods, in part because of the availability of and willingness to use official sector liquidity facilities in periods of aggregate liquidity stress. When banks have access to central bank liquidity facilities priced at terms below private market rates, this might relax the constraints imposed by the composition of banks' balance sheets on their access to external funding, leading to a different relationship between those balance sheet characteristics and the banks' lending (Buch and Goldberg 2014 Leaving the Board).{{p}}{{p}}The Framework for Studying How Liquidity Risks Affect Bank Lending{{p}}Two methodological building blocks underlie the empirical strategy followed in our study. The first is Cornett, McNutt, Strahan, and Tehranian (2011), who examine the role of bank balance sheet composition in explaining how U.S. banks' lending reacts to changes in aggregate liquidity conditions. They posit that banks are more sensitive to aggregate liquidity conditions depending on the market liquidity of their assets, the use of stable core deposits, their capital ratios, and their funding liquidity exposure stemming from loan commitments (or new loan originations via drawdowns).{{p}}{{p}}The second building block is Buch and Goldberg (2014), who integrate into this framework considerations specific to global banks, and also show the potential consequences of bank access to official sector liquidity facilities. For the global banks, strategies for liquidity management can play an important role and these strategies are reflected by the use of internal funding transactions between the head office and its domestic and foreign affiliates. The balance sheet characteristic that reflects this feature of global banks is their reported use of "net due to" or "net due from" their affiliated institutions, which refers to their borrowing from or lending to other parts of the bank holding company.{{p}}{{p}}We focus on a sample of U.S. banks, using data from 2006 through 2012. We concentrate only on larger U.S. banks (with more than $10 billion in assets) and we distinguish between banks with claims booked through foreign affiliates (global banks) and those without such claims (domestic banks). These two groups of banks can lend to both domestic and foreign borrowers. In the case of global banks, lending to foreign residents can be arranged either through cross-border transactions or through their foreign affiliates (which take the form of a subsidiary or branch).{{p}}{{p}}Our measures of aggregate liquidity strains in financial markets are the rates that banks use when lending to one another, known as interbank spreads (such as the London interbank offered rate over the overnight indexed swap, known as the Libor-OIS spread). As shown in the chart below, these rates spiked during the financial crisis as U.S. and European banks became less willing to lend to one another and liquidity dried up, especially at maturities beyond a few days.{{p}}Figure 1: Libor-OIS Spread, U.S. Dollar{{p}}Figure 1: Libor-OIS Spread, U.S. Dollar. This figure shows the U.S. dollar Libor-OIS spread, calculated as the average, within a month, difference between the three-month U.S. dollar London interbank offer rate (Libor) and the Overnight Indexed Swap (OIS) rate for Federal Funds. The horizontal axis ranges from January 2006 until September 2013. The vertical axis shows the difference in percentage points between the Libor and OIS rates. This axis ranges from 0.06 percentage points to 2.94 percentage points. The series starts at 0.07 percentage points in January 2006 and ends at 0.16 percentage points in September 2013.{{p}}{{p}} Source: Bloomberg, L.P.{{p}}{{p}}Our tests take into account banks' use of official sources of liquidity. In 2008, the Federal Reserve announced a number of extraordinary official liquidity facilities to relieve the strains in U.S. financial markets during the crisis. Because the cost of funds at official facilities was at times lower than private market rates, we allow for a different response of individual banks to aggregate prices of liquidity during periods when the bank taps official sector facilities. Thus, our analysis incorporates information by bank on when institutions accessed the Term Auction Facility (TAF) and discount window, and incorporates the balance sheet characteristics of these same financial institutions as well as their global nature to understand differences in the transmission of liquidity risk to loan and credit growth.{{p}}{{p}}What Matters for the Effects of Liquidity Risk{{p}}We find that elevated levels of liquidity risk, as measured by interbank spreads, have significant, but different, effects on lending growth across different types of large U.S. banks. The balance sheet characteristics that matter for these different responses depend on whether the banks are global. For large, non-global banks, the key balance sheet characteristic that explains the impact of a funding shock on loan growth is the share of core deposits in bank funding. The economic impact of having more core deposit funding during a crisis is large: a bank with core deposits representing roughly 76 percent of its total liabilities (in the 75th percentile of the in-sample distribution for this ratio) would lend $211 million more in domestic commercial and industrial (C&I) loans in a given quarter (about 9 percent of domestic C&I loans of the median bank) than a bank with a core deposit share of liabilities of 58 percent (in the 25th percentile of the distribution), after a 100-basis-point increase in the Libor-OIS spread.{{p}}{{p}}By contrast, we find that for global banks, the impact of liquidity shocks depends more on their liquidity management strategies, as reflected in outstanding internal borrowing or lending between the head office and the rest of the organization. Net internal borrowing (liabilities from the head office to its affiliates minus claims by the head office on those affiliates) increases in periods with heightened liquidity risk for the U.S. banks that have higher outstanding unused commitments and lower Tier 1 capital ratios. This higher net internal borrowing is associated with relatively more growth in domestic lending, foreign lending, credit, and cross-border lending. The economic magnitude of the effect of net internal borrowing on domestic C&I loans is also large: a bank that finances 6.6 percent of the head office liabilities (in the 75th percentile) with internal net borrowings would lend $800 million (or 5 percent of domestic C&I lending of the median bank) more in a given quarter than a bank that only finances 1.2 percent of its liabilities (in the 25th percentile) with these funds, after a 100-basis-point increase in the Libor-OIS spread.{{p}}{{p}}We find that cross-border lending and internal borrowing and lending tend to be more volatile than domestic lending and lending conducted through U.S. bank affiliate offices abroad. The model we estimate explains some of the observed changes in domestic loan growth, as well as changes in internal capital market positions, but doesn't capture as much of the volatility in cross-border lending growth of U.S. banks. At the same time, cross-border lending appears to be sensitive to more bank balance sheet characteristics than any of the other forms of lending. Regardless of the form of lending, the role of bank balance sheets is diminished when liquidity risks increase substantially and the banks access official sector liquidity. Thus, official sector liquidity moderates the effects of private sector liquidity risk on both domestic lending and cross-border flows.{{p}}{{p}}{{p}}{{p}}Ricardo Correa is a section chief in the Board of Governors of the Federal Reserve System's International Finance Division.{{p}}{{p}}Linda Goldberg Leaving the Board is a vice president in the Federal Reserve Bank of New York's Research and Statistics Group.{{p}}{{p}}Tara Rice is a section chief in the Board of Governors' International Finance Division.{{p}}{{p}} Disclaimer: IFDP Notes are articles in which Board economists offer their own views and present analysis on a range of topics in economics and finance. These articles are shorter and less technically oriented than IFDP Working Papers.{{p}}Search Working Papers{{p}}{{p}}{{p}}{{p}}Skip Meet Economists Section{{p}}{{p}}Meet the Economists{{p}}All Economists{{p}}By Field of Interest{{p}}Financial Economics{{p}}International Economics{{p}}Macroeconomics{{p}}Mathematical and Quantitative Methods{{p}}Microeconomics{{p}}{{p}}Skip stay connected section{{p}}{{p}}Stay Connected{{p}}Twitter{{p}}YouTube{{p}}RSS Feeds{{p}}Subscribe{{p}}{{p}}{{p}}Last update: October 15, 2014
    Date: 2014–10–15
  2. By: Adrian, Tobias; Moench, Emanuel; Shin, Hyun Song
    Abstract: We empirically investigate predictions from alternative intermediary asset pricing theories. The theories distinguish themselves in their use of intermediary equity or leverage as pricing factors or forecasting variables. We find strong support for a parsimonious dynamic pricing model based on broker-dealer leverage as the return forecasting variable and shocks to broker-dealer leverage as a cross-sectional pricing factor. The model performs well in comparison to other intermediary asset pricing models as well as benchmark pricing models in linear and nonlinear specifications. We find little empirical support for pricing models using intermediary equity as state variable.
    Keywords: intermediary asset pricing; Leverage Cycles; Macro-Finance
    JEL: G10 G12
    Date: 2016–08
  3. By: Claudia Buch; Catherine Koch; Michael Koetter
    Abstract: This paper studies how global banks transmit liquidity shocks via their internal capital markets. The unexpected access of German banks' affiliates located in the United States (US) to the Federal Reserve's Term Auction Facility (TAF) serves as our liquidity shock. Using microdata on all affiliates abroad, we test whether affiliates located outside the US adjusted their balance sheets during periods, when the US-located affiliate of the same parent received TAF loans. Our analysis has three main findings. First, during periods of active TAF borrowing, foreign affiliates of parent banks with high US dollar funding needs reduced their foreign assets by less. We identify those parents based on their pre-crisis exposure to the US asset-backed commercial paper (ABCP) market. Second, foreign affiliates in financial centers also shrank their assets less. Third, there is no evidence that the ABCP exposure per se is driving the reduction of activity outside the US. In sum, our results show that the TAF program spilled over into foreign markets, while highlighting the importance of actively managed internal capital markets and the increased centralization of global banks' liquidity management at the domestic parent during and after the financial crisis.
    Keywords: Term Auction Facility, international banking, liquidity shock, bank funding structure, ABCP exposure
    Date: 2016–08
  4. By: Cavallo, Eduardo; Eichengreen, Barry; Panizza, Ugo
    Abstract: A surprisingly large number of countries have been able to finance a significant fraction of domestic investment using foreign finance for extended periods. While many of these episodes are in low-income countries where official finance is more important than private finance, this paper also identifies a number of episodes where a substantial fraction of domestic investment was financed via private capital inflows. That said, foreign savings are not a good substitute for domestic savings, since more often than not episodes of large and persistent current account deficits do not end happily. Rather, they end abruptly with compression of the current account, real exchange rate depreciation, and a sharp slowdown in investment. Summing over the deficit episode and its aftermath, growth is slower than when countries rely on domestic savings. The paper concludes that financing growth and investment out of foreign savings, while not impossible, is risky.
    Keywords: current account; growth; Savings; volatility
    JEL: F32 O16
    Date: 2016–08
  5. By: Cravino, Javier; Levchenko, Andrei A.
    Abstract: We investigate how multinational firms contribute to the transmission of shocks across countries using a large multi-country firm-level dataset that contains cross-border ownership information. We use these data to document two novel empirical patterns. First, foreign affiliate and headquarter sales exhibit strong positive comovement: a 10 % growth in the sales of the headquarter is associated with a 2 % growth in the sales of the affiliate. Second, shocks to the source country account for a significant fraction of the variation in sales growth at the source-destination level. We propose a parsimonious quantitative model to interpret these findings and to evaluate the role of multinational firms for international business cycle transmission. For the typical country, the impact of foreign shocks transmitted by all foreign multinationals combined is non-negligible, accounting for about 10 % of aggregate productivity shocks. On the other hand, since bilateral multinational production shares are small, interdependence between most individual country pairs is minimal. Our results do reveal substantial heterogeneity in the strength of this mechanism, with the most integrated countries significantly more affected by foreign shocks.
    Keywords: international business cycle comovement; multinational firms
    JEL: F23 F44
    Date: 2016–08
  6. By: Hasan, Iftekhar; Kim, Incheol; Teng, Haimeng; Wu, Qiang
    Abstract: This study examines whether foreign institutional investors (FIIs) help explain variation in corporate tax avoidance and whether mechanisms such as tax morality, investment horizon, and corporate governance underlie the relation between FIIs and tax avoidance. We find robust evidence that FIIs are negatively associated with corporate tax avoidance. Moreover, this negative association is dominated by FIIs from countries with high tax morality, FIIs with long-term investment horizons, and FIIs from countries with high corporate governance quality. We conclude that FIIs play an active role in shaping corporate tax avoidance policy.
    Keywords: tax avoidance, foreign institutional ownership, tax morale, investment horizon, corporate governance
    JEL: G23 G32 H26 M41
    Date: 2016–08–23

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