Bank loan supply during crises: the importance of geographic diversification

Focus

The Great Financial Crisis led to a sharp decline in cross-border banking integration, putting an end to the steady increase in such integration over previous decades. Policymakers and academics have sought to better understand the effects of globally integrated banks on financial stability and the real economy. Several papers provide valuable evidence on the costs and benefits of lending by foreign banks. However, an analysis of how banks' global integration affects financial stability is largely absent from this literature.

Contribution

This paper aims at empirically assessing the effect of banks' global integration on loan supply during banking crises in a cross-country setting. We provide the first evidence for the beneficial effects of banking integration across countries - their geographic diversification - on local loan supply. Moreover, we complement previous findings on the role of banks' nationality by investigating the interaction of banks' nationality with their geographic diversification. Detailed loan-level data on syndicated loans allow us to identify loan supply effects and to trace out the real effects on borrowing firms.

Findings

We use detailed loan-level data on worldwide syndicated lending to investigate how geographic diversification affects banks' loan supply during banking crises in their host countries. To identify globally integrated banks, we construct a Herfindahl Index of the geographic diversification of banks' international loan portfolios. We find that diversified banks stabilise loan supply and smooth local shocks in borrower countries: they supply more credit during crises than do banks holding a more concentrated portfolio. Higher loan supply leads to higher investment and employment growth for firms borrowing from diversified banks. We establish that better access to new funds during times of distress helps banks with diversified portfolios to keep lending.

Abstract

We classify a large sample of banks according to the geographic diversification of their international syndicated loan portfolio. Our results show that diversified banks maintain higher loan supply during banking crises in borrower countries. The positive loan supply effects lead to higher investment and employment growth for firms. Diversified banks have a stabilizing effect, thanks to their ability to raise additional funding during times of distress, which also shields connected markets from spillovers. Further distinguishing banks by nationality reveals a pecking order: diversified domestic banks are the most stable source of funding, while foreign banks with little diversification are the most fickle. Our findings suggest that the decline in financial integration since the recent crisis increases countries' vulnerability to local shocks.

JEL codes: F30, G2

Keywords: global banks, diversification, syndicated loans, financial crisis