Which Way Do Foreign Branches Sway? Evidence from the Recent UK Domestic Credit Cycle

Abstract

Foreign bank branches have a significant presence in the United Kingdom’s financial sector, more so than in any other major advanced economy. A lot of their business activities are with non-residents but they are also important sources of credit for UK financial and non-financial companies. During the recent crisis, the growth in credit to UK borrowers from foreign branches fell sharply and by much more than from UK-incorporated banks. Using a combination of aggregate and individual bank-level data, this paper explores why foreign branches’ UK lending was much more cyclical. Both demand and supply factors appear to have been important. The domestic loan book of foreign branches was more concentrated on cyclical sectors than that of UK-incorporated banks. But it was also the case that their lending to most domestic sectors increased more rapidly in the run-up to the crisis and fell more subsequently. Foreign branches were also more reliant on fickle forms of funding, especially from abroad. Going forward, it is important the Financial Policy Committee and Prudential Regulation Authority closely monitor the risks that foreign branches, particularly large ones, may pose to UK financial stability and to the broader economy.