Financial stress in lender countries and capital outflows from emerging market economies

Summary

Focus

We study if financial stress in countries where international banks are headquartered is a major driver of capital outflows from emerging market economies (EMEs). We use data on bilateral banking outflows from 67 EMEs using BIS consolidated and locational banking statistics for 27 and 29 lender countries, respectively. We also examine which component of international lending to EMEs is more susceptible to financial stress in lender countries.

Contribution

As proxies for financial stress in lender countries, we use bank CDS spread, sovereign CDS spread and corporate bond spread. In addition, we decompose foreign bank claims in various components, such as cross-border claims, local claims in foreign currency and local claims in local currency by estimating the first two components from BIS consolidated banking statistics.

Findings

We find that when financial stress of lender countries increases, international banks decrease their lending to EMEs, which acts as a major driver of capital outflows from EMEs. In particular, financial stress in lender countries is a more important driver than the local financial conditions and macroeconomic fundamentals of EMEs. When we consider the subcomponents of the total amount of international lending, cross-border lending to EMEs is more susceptible to financial stress in lender countries than is local lending in foreign currency.

Abstract

We investigate if financial stress in countries where international banks are headquartered is a major driver of banking outflows from emerging market economies (EMEs). We find that when financial stress measured by sovereign or bank CDS spread or corporate bond spread increases, international banks decrease their lending to EMEs, which acts as a major driver of capital outflows from EMEs. In particular, financial stress in lender countries is a more important driver than the local financial conditions and macroeconomic fundamentals of EMEs. Such results generally hold even after the Global Financial Crisis (GFC) period, but to a lesser extent. When we divide the total amount of international lending into subcomponents, cross-border lending to EMEs is more susceptible to financial stress in lender countries than is local lending, and that local lending in foreign currency is more stable than is cross-border lending. Our findings suggest that it is desirable for EME policymakers to promote diversification of lender countries and induce more borrowing from local subsidiaries than cross-border lenders.

JEL classification: E44, F15, F21, F34, F38

Keywords: capital outflows, cross-border claims, emerging market economies, financial stress, local claims