Uncertainty and Cross-Border Banking Flows*

Abstract

While global uncertainty-measured by the VIX-has proven to be a robust global i°pushi± factor of international capital flows, there has been no systematic study assessing the role of uncertainty in driving bilateral capital flows. This paper tries to fill this gap in the literature by examining the effects of higher country-specific uncertainty on cross-border banking flows using data from the Bank for International Settlements Locational Banking Statistics. The bilateral structure of this data allows to disentangle supply factors from demand factors, thereby helping identify the effect of higher uncertainty on cross-border banking flows from other confounding factors. The results of this analysis suggest that: (i) uncertainty in a source country (domestic economy) is both a lender-specific push and pull factor that robustly predicts a decrease in outflows (cross-border lending) and inflows (crossborder borrowing); (ii) a decline in cross-border borrowing is larger than a decline in cross-border lending so that the net cross-border position of the banking sector increases; (iii) despite a decline in cross-border bank lending in the absolute sense, the share of cross-border bank lending in total bank lending increases, suggesting a portfolio rebalancing; (iv) this rebalancing occurs only when banks are lending to borrowers in advanced economies, not those in emerging market economies.