Foreign banks, liquidity shocks, and credit stability

Focus

The paper asks whether the syndicated loan portfolio of banks in the United States reacted differently to the regulatory change for deposit insurance in 2011. The increase in the insurance fee levied on banks to fund the Federal Deposit Insurance Corporation's fund had varying effects among US banks, increasing the cost of wholesale funding for insured domestic banks, while reducing it for uninsured foreign bank branches. This might have affected the credit supply at insured banks and uninsured foreign banks in differing ways.

Contribution

The paper contributes to the discussion on the role of foreign banks in credit creation, especially in a country like the United States where foreign banks also have a crucial role in managing US dollar-based money market operations at the group level. The literature has already shown that foreign banks which benefited from the favourable funding shock reacted by increasing their reserves holdings. Our paper seeks to investigate more deeply the effect on the syndicated loan market. To do this, we use a data set at the bank-firm level that was obtained by hand-matching data from the syndicated loan market with banks' balance sheet data. The data set's granularity lets us better quantify the effects of the policy-driven liquidity shock on the loan supply.

Findings

The paper finds that uninsured foreign banks, which met with a relatively positive funding shock, did engage in liquidity hoarding. Hence, they accumulated more reserves but extended fewer total syndicated loans. They also became more passive in the syndicated loan deals in which they participated. These results are robust even after controlling for the effects of the European debt crisis and other home country-specific shocks.

Abstract

We empirically assess the responses of banks in the United States to a regulatory change that influenced the distribution of funding in the banking system. Following the 2011 FDIC change in the assessment base, insured banks found wholesale funding more costly, while uninsured branches of foreign banks enjoyed cheaper access to wholesale liquidity. We use quarterly bank balance sheet data and a rich data set of syndicated loans with borrower and lender characteristics to show that uninsured foreign banks, which faced a relatively positive shock, engaged in liquidity hoarding. Hence, they accumulated more reserves but extended fewer total syndicated loans and became more passive in the syndicated loan deals in which they participated. These results contribute to the discussion on the role of foreign banks in credit creation, especially in a country like the United States where foreign banks also have a crucial role in managing USD money market operations at the group level.

JEL classification: G21, G28, E44

Keywords: foreign banks, liquidity shocks, wholesale funding, syndicated loans