International Banks and the Cross-Border Transmission of Business Cycles

Abstract

We study the link between the cross-border funding activities of global banks and the international transmission of business cycles. First, using a dataset compiled by the Federal Reserve Board, we document three stylized facts about the operations of foreign banks in the United States: (i) The net borrowing of foreign branches from their parent banks is procyclical with the U.S. economy. (ii) The lending of foreign branches to U.S. firms is procyclical, and also more volatile than the lending of the domestically chartered banks. (iii) The lending of foreign subsidiaries to small U.S. firms is procyclical and more volatile than the corresponding lending by U.S. banks, indicating the presence of an extensive margin in foreign banks' lending to U.S. firms. Second, we build a two-country, dynamic stochastic general equilibrium model to explain these cyclical fluctuations in international bank lending and study their macroeconomic implications. In the model, each economy consists of: one representative household that provides bank deposits; two types of banks, and global, where the latter collects deposits from abroad and issues loans to foreign firms in addition to its domestic operations; a continuum of monopolistically-competitive firms that are heterogeneous in labor productivity, and that choose endogenously to borrow working capital from either the local or the global bank. Our model provides a framework to analyze the economic impact of proposed Basel III liquidity regulations.