Home sweet host: Prudential and monetary policy spillovers through global banks

Focus

We study whether prudential policies enacted in one country affect banks' lending to other countries, and how monetary policy affects these spillovers. We distinguish between the policies enacted by a bank's home country (where it is headquartered) and a bank's host country (where it operates). To do so, we develop a novel approach that separates cross-border bank lending into the home and host parts and matches them with home and host policies.

Contribution

Banks face an overlay of regulations applied by their home country and their host country. There is little research on how these regulatory layers relate to each other. Our paper looks at the effects of home and host regulation (jointly and separately) on cross-border lending in a large sample. We further contribute a new empirical framework that can be used more broadly for related issues.

Findings

We find that prudential policies do produce spillovers through cross-border bank lending. The effect depends on the instrument used and whether the home or host regulator implemented the policy. Home policies tend to have larger effects, and US monetary policy can affect the magnitude of these spillovers.

Abstract

Prudential regulation of banks is multi-layered: policy changes by home-country authorities affect banks' global operations across many jurisdictions; changes by host-country authorities shape banks' operations in the host jurisdiction regardless of the nationality of the parent bank. Which layer matters most? Do these policies create cross-border spillovers? And how does monetary policy alter these spillovers? This paper examines the effect that changes in home- and hostcountry prudential measures have on cross-border credit, and how these interact with monetary policy. We use a novel approach to decompose growth in cross-border bank lending into separate home, host and common components, and then match each with the home or host policies that affect this component. Our results suggest that prudential policies can have spillover effects, which depend on the instrument used and on whether a bank's home or host country implemented them. Home policies tend to have larger spillovers on cross-border US dollar lending than host policies, primarily through substitution effects. We also find that a tightening of US monetary policy can compound the spillovers of certain prudential measures.

JEL classification: F42, G21, L51.

Keywords: international banking, prudential policy, international policy coordination and transmission, currencies, international spillovers