Do Multinational Banks Use Internal Capital Markets and How?: Evidence from Bank-Level Panel Data in Emerging Economies

Abstract

This paper examines internal capital markets between multinational banks and their foreign subsidiaries. We observe the lending behavior of more than 300 subsidiaries within 69 multinational banks from 24 home countries, which conducted banking activities in 50 emerging and developing countries during the period 1994-2008, and find robust evidence for the operation of internal capital markets. Foreign subsidiaries increase their credit in host countries when their parent banks have higher internally added funds, and the funds available from parent banks reduce the sensitivity of subsidiaries to their own internal funds. We also find that the funds from parent banks are allocated in favor of smaller and less profitable subsidiaries. Higher capitalization of subsidiaries enhances the buffering effects of parent bank internal funds on subsidiaries’ own internal funds, suggesting that foreign subsidiaries could insulate the effects caused by an adverse shock upon their parent banks by raising their own capital sufficiency. Our findings have useful implications for internal capital markets in multinational banking as a channel of the contagion of the recent global financial crises from the U.S. to various other countries.