Foreign Lending Research Articles

Understanding Exchange Rate Movements during the 2008 Financial Crisis

During the 2008 financial crisis, many advanced economies, whose banking systems suffered significant capital losses, experienced large and rapid exchange rate depreciations followed by prolonged and gradual appreciation in subsequent periods. In order to understand one possible explanation of these observed exchange rate movements, we develop a simple model of a highly leveraged banking sector in which banks obtain part of their funding from abroad. A fall in bank net worth leads to foreign lenders demanding a higher risk premium on credit supplied to domestic banks. This higher risk premium can be met if the exchange rate experiences an appreciation along the adjustment path, since this raises the value of the bank's earnings in terms of the foreign currency for every period that the foreign risk premium is elevated. In order for the exchange rate to appreciate by a large amount along the adjustment path, it must initially become undervalued – relative to its long-run level – so that in equilibrium the market is willing to bid up its value in subsequent periods. This thus gives rise to the large initial depreciation of the exchange rate followed by its prolonged and gradual appreciation.

Capital Inflows, Exchange Rate Flexibility and Credit Booms

AbstractHistorically, capital flow bonanzas have often fueled sharp credit expansions in advanced and emerging market economies alike. Focusing primarily on emerging markets, this paper analyzes the impact of exchange rate flexibility on credit markets during periods of large capital inflows. It is shown that bank credit is larger and its composition tilts to foreign currency in economies with less flexible exchange rate regimes, and that these results are not explained entirely by the fact that the latter attract more capital inflows than economies with more flexible regimes. The findings thus suggest countries with less flexible exchange rate regimes may stand to benefit the most from regulatory policies that reduce banks' incentives to tap external markets and to lend/borrow in foreign currency; these policies include marginal reserve requirements on foreign lending, currency‐dependent liquidity requirements and higher capital requirement and/or dynamic provisioning on foreign exchange loans.

Costly information, entry, and credit access

Using a theoretical model that incorporates asymmetric information and differing comparative advantages among lenders, this paper analyzes the impact of lender entry on credit access and aggregate net output. The model shows that lender entry has the potential to create a segmented market that increases credit access for those firms targeted by the new lenders but potentially reduces credit access for all other firms. The overall impact on net output depends on the distribution of firms, the relative costs of lenders, and the cost of acquiring information. The model provides new insights into the evidence regarding foreign lenders' entry into emerging markets.

Ways to Stimulate Banking Activity on Investment and Credit Markets

The current situation of Ukrainian banks on credit and investment markets is very complicated. During 2009-2012 , the banking system was going through hard times, eliminating the effects of the financial crisis of 2008, that resulted in the strengthening of banks’ claims on borrowers; active banks’ work with non-performing loans, the volume of which rapidly was increasing due to the devaluation of the hryvnia, increased use of liquidity regulation tools of NBU because of decreasing of confidence in the banking system; increasing foreign exchange risk , which was caused by the contraction of foreign currency lending and rising interest of depositors in foreign currency deposits. The purpose of this paper is to search for practical problems that stand in the way of effective implementation of credit and investment potential of Ukraine's banking system and developing proposals to eliminate them.

Borrowing Beyond Borders: Foreign Assets, Lender Choice, and Loan Pricing in the Syndicated Bank Loan Market

This paper examines the ability of firms to overcome cross-country borrowing barriers through foreign asset connections. We find that firm-level foreign assets are an important mechanism in reducing the boundary between borrowers and lenders and thereby enhancing capital access in the syndicated loan market. Our results suggest that firms with foreign assets are more likely to select a foreign lead lender and that the corresponding loans have better pricing terms. We also find that the institutional and regulatory environment heavily influences the choice of lender, and that borrowers are more likely to partner with bankers with whom they share common cultural and language ties. These results lend support to the hypothesis that foreign presence helps reduce information barriers that may arise across borders.

Industry Audit Experts and Ownership Structure in the Syndicated Loan Market: At the Firm and Partner Levels

SYNOPSIS The PCAOB has recently issued two concept releases that seek feedback on a proposal that requires audit firms to disclose the name of the engagement partner in the audit report. This paper provides evidence about the efficacy of this proposal by examining whether industry audit experts at the partner level are valued by stakeholders—lenders in the syndicate loan market. Our paper is based on the unique data in Taiwan, where the audit report is issued in the name of two signing auditors, as well as the audit firm. Prior research suggests that lead arrangers prefer to hold a lower share of the loan and to have a larger number of other lenders. First, we find no evidence that Big 4 audit firms are related to the lower share of a syndicated loan held by the lead arrangers, after controlling for industry audit expertise; we also find no evidence that firm-level expertise alone is associated with the share held by lead arrangers. However, we do find that partner-level industry audit experts, either alone or in conjunction with a firm-level industry audit expert, are associated with the lower share of syndicated loans held by lead arrangers. Second, we find that the number of lenders in general (or the number of foreign lenders in particular) in a loan is the largest when borrowers retain industry audit experts at both the firm and partner levels.

Does Foreign Bank Entry Improve Credit Allocation and Lending Rates?: Evidence from Indonesia

This study aims to investigate the impact of the existence of foreign banks on the allocation of loans and lending rates in Indonesia. The first part of this study examines the impact of the ownership types of the foreign banks on credit allocation based on borrower types, i.e: corporations and small and medium enterprises (SMEs), and loan currency. In addition, we estimate determinants of lending rate, by taking into account the impact of foreign bank’s modes of entry, bank characteristics, macroeconomics variables, and bank market structure. This study found that foreign banks that enter the Indonesian banking market via Greenfield investments and takeover tend to channel lower proportion of credit for the SMEs. In addition, Greenfield foreign banks provide more loans in foreign currency, a result that can be explained by the notion that foreign banks have better access to world capital market and possibly serve more large firms and foreign clients in foreign currencies. The last result confirms that Greenfield banks in general charge lower lending rates on the credits.

COMPETITION IN THE DUTCH MORTGAGE MARKET: NOTES ON CONCENTRATION, ENTRY, FUNDING, AND MARGINS

This article describes the institutions that shape the Dutch mortgage market, as well as how they affect mortgage funding, and, ultimately, mortgage interest rates. The Dutch housing market is characterized by a very large social housing sector, as well as a relatively large share of owner-occupied housing. The private rental sector is underdeveloped. As a result, Dutch residents buy their first house at a relatively young age, with low personal savings and a mortgage loan that has a high loan-to-value ratio. Banks in The Netherlands rely heavily on international capital markets for funding, and the financial crisis has had a strong impact on funding costs. In our view, the increase in funding costs is the main cause of the increase in mortgage interest rates and the exit of several foreign lenders after the start of the financial crisis. We also discuss the investigation into mortgage interest rates that was carried out by the Netherlands Competition Authority.

Current account and fiscal imbalances in the Eurozone: Siamese twins in an asymmetrical currency union

The paper aims at connecting fiscal and external imbalances in the Eurozone. After the shock of the 2007 financial crisis, the current account position was the root cause of discriminatory behavior of foreign lenders towards single countries. Once the interaction between the current account and fiscal imbalances started, the only way out to restore stability and stem capital outflows was to implement fiscal retrenchments and real devaluation. The choice governments of peripheral countries face is therefore, at least in the short run and in recessive conditions, either to restore the equilibrium to their public finance, or to counteract the real shocks coming from the crisis. This suggests to consider that the stability of the Eurozone could be realized at expenses of a lower output in peripheral countries.

Foreign bank lending: Evidence from the global financial crisis

We exploit highly disaggregated bank-firm data to investigate the dynamics of foreign vs domestic credit supply in Italy around the period of the Lehman collapse, which brought a sudden and unexpected deterioration of economic conditions and a sharp increase in credit risk. Taking advantage of the presence of multiple lending relationships to control for credit demand and risk at the individual-firm level, we show that foreign lenders restricted credit supply (to the same firm) more sharply than their domestic counterparts. A number of exercises testing alternative explanations for this result suggest that such more intense restriction also reflects the (functional) distance between a foreign bank's headquarter and the Italian credit market.

Effects of Foreign Institutional Ownership on Foreign Bank Lending: Some Evidence for Emerging Markets

Despite the large literature on developed countries, little is known about the interactions between corporate governance, foreign ownership, and foreign bank lending in developing countries. Using data from five Latin American countries from 2001 to 2008, we provide one of the first pieces of evidence of how foreign ownership affects the loan cost of borrowers in emerging markets. We find that in terms of foreign bank lending, the cost of debt financing is significantly higher for firms whose largest shareholder is a foreign institutional one. The results support the hypothesis that because of potential agency conflicts between shareholders and creditors, having block institutional shareholders tend to increase the borrowers’ debt burden. There is further evidence supporting this agency conflict hypothesis as we find that the effects of large institutional shareholders on borrowing costs become larger (smaller) when the conflicts are aggravated (mitigated).

The Effects of Ratings-Contingent Regulation on International Bank Lending Behavior: Evidence from the Basel 2 Accord

We investigate the effects of credit ratings-contingent financial regulation on foreign bank lending behavior. We examine the sensitivity of international bank flows to debtor countries’ sovereign credit rating changes before and after the implementation of the Basel 2 risk-based capital regulatory rules. We study the quarterly bilateral flows from G-10 creditor banking systems to 77 recipient countries over the period Q4:1999 to Q2:2013. We find direct evidence that sovereign credit re-ratings that lead to changes in risk-weights for capital adequacy requirements have become more significant since the implementation of Basel 2 rules for assessing banks’ credit risk under the standardized approach. This evidence is consistent with global banks acting via their international lending decisions to minimize required capital charges associated with the use of ratings-contingent regulation. We find evidence that banking regulation induced foreign lending has also heightened the perceived sovereign risk levels of recipient countries, especially those with investment grade status. Keywords: cross-border banking, sovereign credit ratings, Basel 2, rating-contingent financial regulation

The Real Effect of Foreign Banks*

Although foreign banks can act as catalysts for financial and economic development, their role remains controversial because they might displace local lending, thereby tightening firms’ overall access to credit. We study the economic channels through which domestic lending by foreign banks affects real economic activity in a large cross-section of developing and advanced countries. We find that foreign lending alleviates financial constraints and increases real growth net of the competitive reaction of local lenders. In addition to providing stable access to credit, foreign banks also mitigate the consequence of informational and legal obstacles to lending, especially in developing credit markets.

Financial liberalization, market structure and credit penetration

Abstract This paper shows that the effects of financial liberalization on the credit market of a small and capital constrained economy depend on the market structure of domestic banks prior to liberalization. Specifically, under perfect competition in the domestic credit market prior to liberalization, liberalization leads to lower domestic interest rates, in turn leading to increased credit penetration. However, when the initial market structure is one of imperfect competition, liberalization can lead to the exclusion of less wealthy entrepreneurs from the credit market. This provides a rationale for the mixed empirical evidence concerning the effects of liberalization on access to credit in developing markets. Moreover, the analysis provides new insights into the consequences of foreign lenders’ entry into developing economies.

Foreign Banks and the Dual Effect of Financial Liberalization

In emerging countries, credit market liberalization is often motivated with the financial deepening generated by the entry of foreign financial institutions. However, there is a risk that liberalization may benefit internationally active, export‐oriented businesses at the expense of domestically oriented ones. This paper models a two‐sector economy in which foreign lenders are more efficient than local lenders at extracting value from internationally tradable collateral assets. Under some conditions the entry of foreign lenders eases entrepreneurs’ access to the credit market and raises asset prices and output, but in other circumstances it reduces the depth of the credit market and depresses the price of nontradables and output. Liberalization can have a contractionary impact by inducing a reallocation of credit from the nontradables to the tradables sector.

The policy (in)effectiveness of government spending in a dependent economy

This paper analyses the policy effectiveness of government spending in a two-sector open economy whose output and expenditure is comprised of tradables and non-tradables. This framework reveals that government spending on either tradables or, more normally, on non-tradables widens the external deficit, yet how the real exchange rate behaves depends, in the first instance, on in which sector the public spending occurs. It also shows that, irrespective of where government spending falls, there appears to be no significant short run boost to overall output and hence employment a priori, although empirically actual impact would depend on the elasticities of tradable and non-tradable output with respect to the real exchange rate. Furthermore, fiscal stimulus is shown to be unambiguously ineffective if deemed unsustainable by foreign lenders, or implemented under a fixed exchange rate regime with limited capital mobility.

Bridging jurisdictions: security arrangements under Turkish law

Turkey has been following a very foreign-investor-friendly policy for the past decade. A relatively stable economy and a high-return, pro-investment environment has enabled sponsors to bring home a considerable slice of the emerging markets pie both in terms of private equity investments and financing. Particularly in the context of financing, interest from foreign lenders led to a somewhat inevitable clash of cultures between the predominantly common-law-based approach of the international lending market and Turkish law. In this article, we set out to explore how well the two cultures mesh together, focusing on the area where perhaps the need for unison is most apparent – security arrangements. We have tried to set out the fundamental principles that govern security arrangements under Turkish law and to give the reader a basic understanding of the issues and in particular of the market for security arrangements. It is our hope that this article will be of benefit not only to legal practitioners but also that it will help bridge the jurisdictional gap for bankers, investors and sponsors.

A Nation of Deadbeats: An Uncommon History of America's Financial Disasters

Easy credit supplied by overleveraged lenders, complex financial instruments, a mortgage bonanza, unregulated banks, rising land values, and growing uncertainty—all followed by a cataclysmic bust—is not the story of the 2008 financial crisis but rather the tale of the panic of 1837, in the hands of Scott Reynolds Nelson. A Nation of Deadbeats offers a fresh interpretation of America's past panics viewed through the stories of speculators, funny-money, bad debt, and bad borrowers. As Nelson explains, the United States is a nation of deadbeats. The 2008 financial collapse should have come as no surprise. Nelson's book traces the causes of America's financial panics and also the consequences (often in the form of “crash politics”) that have shaped U.S. history in not-so-obvious ways (p. 32). The gist of his narrative is that consumer debt, frequently fed by foreign lenders using instruments of dubious transparency, piles up and feeds asset bubbles that then burst with disastrous, often-global consequences. The resulting political fallout can change the shape of policy and society for decades. Further, “debt” is no villain here. Borrowing represents optimism in the future, adventurous risk, and, ironically, independence from colonial chains. For Nelson, “defaulters are often dreamers” (p. xiii).

Lending constraints, real estate prices and business cycles in emerging economies

We investigate a small open economy with constraints in both the domestic and the international credit market. The informational opaqueness of the domestic market hinders foreign lenders' activity, so that entrepreneurs face looser borrowing constraints vis-à-vis domestic financiers. However, limited capitalization constrains domestic lenders. Calibrating the model to data from Argentina, we find that the interaction between lending and borrowing constraints is a channel through which real interest rate shocks generate fluctuations in output, real estate prices and consumption. External financial liberalization increases volatility and affects welfare more than domestic liberalization but also mitigates the destabilizing impact of domestic deregulation.

The Procyclicality of Foreign Bank Lending: Evidence from the Global Financial Crisis

We exploit highly disaggregated bank-firm data to investigate the dynamics of foreign vs. domestic credit supply in Italy around the period of the Lehman collapse, which brought a sudden and unexpected deterioration of economic conditions and a sharp increase in credit risk. Taking advantage of the presence of multiple lending relationships to control for credit demand and risk at the individual-firm level, we show that foreign lenders restricted credit supply (to the same firm) more sharply than their domestic counterparts. Based on a number of exercises testing alternative explanations for such procyclicality, we find that it mainly reflects the (functional) distance between a foreign bank’s headquarters and the Italian credit market.