Uneven regulatory playing field and bank transparency abroad

Tai-Yuan Chen,Tai-Yuan Chen,Mingyi Hung,Yi-Chun Chen

doi:10.1057/s41267-021-00491-6

Abstract

Motivated by international business research on institutional arbitrage and headquarters–subsidiary relationships, we examine the effect of regulatory distance on multinational banks’ (MNBs) reporting transparency abroad. Using an international sample of foreign subsidiary banks in 46 host countries from 47 home countries, we find that bank transparency declines when the home countries have tighter activity restrictions than the host countries. We bolster the causal inference using difference-in-differences designs that take advantage of banking reforms and cross-border bank acquisitions. We also find that the result is more pronounced when parent banks have lower capital ratios or when host countries have weaker supervisory power, suggesting that parent banks use opaque reporting to conceal risk-taking abroad. Further analysis finds that less transparent subsidiaries are more likely to fail during financial crises. Overall, our findings suggest that regulatory distance creates negative externalities for bank transparency and stability abroad.

Highlights

Multinational banks (MNBs) play an important role in promoting international business through financing global transactions of multinational corporations and maintaining the stability of the global financial system (Fang, Hasan, Leung, & Wang, 2019; Laeven, 2013)
We control for the following bank characteristics that explain banks’ financial reporting quality (Kanagaretnam et al, 2014): (1) SIZE, the log of lagged total assets; (2) ROA, return on assets; (3) LOAN GROWTH, the growth of total loans; (4) CAPITAL RATIO, shareholder equity divided by total assets; (5) BIG 5, a variable indicating whether the subsidiary is a client of a Big Five auditor; and (6) PUBLIC, a variable indicating whether the subsidiary is publicly listed
Because parent banks likely determine their financial reporting practices based on the strength of bank supervision and deposit insurance, we control for DSUPV POWER, an index that measures the extent to which the bank supervisors can take specific actions to prevent or correct problems, and DDEPOSIT INS, an indicator variable equal to one if there is explicit deposit insurance and depositors were fully compensated the last time a bank failed

Summary

INTRODUCTION

Multinational banks (MNBs) play an important role in promoting international business through financing global transactions of multinational corporations and maintaining the stability of the global financial system (Fang, Hasan, Leung, & Wang, 2019; Laeven, 2013). We measure regulatory distance as the differences in an index of bank activity restrictions between the foreign subsidiaries’ home and host countries This index, obtained from Barth et al (2013), captures the restrictiveness of bank regulations on nonlending activities, including trading securities, providing insurance, and investing in real estate. Majority-owned subsidiaries, 1995–2009 Subsidiaries without direct ownership M&A targets Domestic subsidiaries Subsidiaries without financial statement data Missing bank regulation index Missing required variables (including loan or securities) and only one in host country-year. Given that tighter activity restrictions at home lead to lower lending standards and more investment activities abroad (Karolyi & Taboada, 2015; Ongena et al, 2013), the disclosures related to loans and securities can directly capture the effect of regulatory distance on bank transparency.

EMPIRICAL RESULTS

DISCLOSURE

Disclosure

CONCLUSIONS