How Did the Crisis in International Funding Markets Affect Bank Lending? Balance Sheet Evidence from the UK

Abstract

Listen

Translate article

Evidence abounds on the propagation of financial stresses originating in the US mortgage market to banking systems worldwide through international funding markets. But the transmission of this external funding shock to the real economy via bank lending is surprisingly under-examined, given the central importance ascribed to this channel of contagion by policymakers. This paper provides evidence of this transmission for the UK-resident banking system, the largest in the world by asset size. It uses a novel dataset, created from detailed balance sheet data reported by resident banks quarterly to the Bank of England. It finds that the shock to foreign funding during the financial crisis caused a substantial pullback in domestic lending. A range of instrumental variables are used to correct for endogeneity and omitted variable bias, and the results are robust to various sensitivity tests. Resident subsidiaries and branches of foreign-owned banks reduced lending by a larger amount than domestically-owned banks, while the latter calibrated the reduction in domestic lending more closely to the size of the funding shock.