The decade before the 2007–09 global financial crisis was characterized by a significant increase in bank globalization, which also coincided with dramatic increases in bank size. International banks became the cornerstone of many financial systems around the world, also in developing countries. Proponents of international banking emphasized the potential gains in terms of much-needed capital, know-how, and technological improvements that foreign banks bring, leading to more competitive and diversified banking systems, improved resource allocation, and greater financial and economic development.
However, the global financial crisis has led to a significant re-evaluation of this conventional wisdom. With the crisis, there was a backlash against globalization in general, and the emphasis shifted to the role international banks can play in shock transmission. Developing countries felt the impact of retrenchment by global banks. Global banks were criticized for taking excessive risks. Financial Stability Board (FSB) and the G20 voiced concerns about how to deal with the resolution of too-big-to-fail banks. As a result, regulations and restrictions got stricter in many countries, particularly in developing countries, further contributing to the retrenchment kicked off by the crisis.
Global Financial Development Report 2017/2018: Bankers without Borders, the fourth in the series, brings to bear new evidence on the debate on the benefits and costs of international banks, particularly for developing countries. It provides figures on recent trends, emerging patterns since the global crisis, and evidence on the economic impact of international banking. The goal is to synthesize evidence and data to contribute to the policy debate on international banking.
What do we know about recent trends in international banking?
Following a decade of increased globalization, international banking suffered a setback after the global financial crisis. The globalization trend has been partially reversed with international banks from high-income countries — “the North” — scaling back their operations. Net foreign bank entry became negative. While banks from high-income countries drove exits, developing country banks continued their international expansion, accounting for the bulk of new entry into foreign markets. Cross-border bank claims and syndicated loans also saw significant retrenchment, but “South-South” transactions — from developing countries to other developing countries — started to grow. This greater South-South activity has also coincided with regionalization both in the roster of foreign banks in many host countries, as well as cross-border flows. Despite the setback, international bank lending remains a vital source of finance for developing countries, although its composition has been changing since the crisis. Moreover, although regulatory barriers to foreign banking increased over this period, large international banks continued to become larger.
Cross-Border and Local Claims by Foreign Banks, 2005–15
Local claims through foreign bank presence have been more resilient than cross-border bank flows, and internationalization of developing country banks contributed to that resilience.
Source: Consolidated Banking Statistics (Ultimate Risk Basis), Bank for International Settlements.*
The report distills a large body of evidence to contribute to the policy debate.
Research evidence from decades of work confirms international banking activities have the potential to improve the degree of competition in the local banking sector, help upgrade skills, and improve the efficiency of resource allocation. Risks can be shared and diversified. Through threat of exit, international banking can also discipline domestic financial policies, regulations and supervisory practices and weaken the political entrenchment between domestic financial institutions and governments. Overall, more capital and increased efficiency of allocation promote faster economic development and greater financial stability. Hence remaining open despite rising protectionism is essential for countries to continue to benefit from global flows of funds, knowledge, and opportunity.
However, international banking does not simply guarantee financial development and stability. Openness also introduces more volatility and exposes the countries to foreign exchange risks, foreign monetary policy shocks, and other mismatches. In weak institutional environments with sparse information, contract enforcement and inadequate regulation and supervision, global finance may lead to destabilizing boom-bust cycles; and competition from foreign banks may drive out domestic banks and reduce access to finance and inclusion. Moreover, risk-sharing has two sides. International banks that export risks will also import them. Also, international banking can magnify the impact of risk-taking distortions that exist in domestic bank policy, regulation, and safety-nets.
Policymakers have a vital role to play in maximizing the benefits of international banking while keeping the risks under control. Research suggests that institutionally better-developed countries tend to reap both more of the development and risk-sharing benefits from international banking. Specifically, good information sharing, property rights, contract enforcement and strong regulation and supervision are key. Importantly, it is these improvements that prevent foreign banks from just displacing domestic banks and exploiting regulatory weaknesses. Moreover, with strong institutions both the foreign banks and domestic banks that are now exposed to greater competition can go down market and improve access and inclusion for SMEs and households that were previously excluded.
Research suggests that for designing effective policies, it is also important to keep in mind differences in bank characteristics and home and host country conditions. For development considerations, larger banks and those that are culturally closer, with a higher share of domestic financial intermediation including deposit taking, tend to provide better access to SMEs and households and are less likely to concentrate only on the large customers. As for stability, the risk sharing benefits of globalization need to be considered over the long term. Cross-border flows tend to be more volatile and less resilient than brick and mortar bank presence. Foreign banks with greater commitment, as reflected in closeness both in distance to headquarters and in culture, that have larger local market shares, and rely more heavily on local funding, are more willing to incur temporary costs when faced with external shocks and to support the local economy. However, encouraging the right type of foreign bank entry or capital flows without causing distortions is challenging.
There is much more in the report on the recent trends that are shaping bank globalization — South-South Banking and Fintech — and their implications for policy. The webpage includes the background papers, as well as several updates of major datasets on financial systems: http://www.worldbank.org/financialdevelopment. Stay tuned for further blog posts that will delve further into the findings and data from the individual chapters of the report.
World Bank, 2018, Global Financial Development Report 2017/2018: Bankers without Borders. Washington, DC: World Bank.
*Note: Figures are country-level averages by income level of the borrowing countries over the period 2005–15. Borrowing countries are categorized as high-income and developing countries according to the World Bank’s country classifications as of 2017. Cross-border claims refer to those extended by foreign bank offices outside the borrower’s jurisdiction. Local claims refer to those extended by foreign bank offices within the borrower’s jurisdiction. Total ratios of outstanding values to gross domestic product are provided in each case.
The World Bank report Bankers without Borders is not associated with the Grameen Foundation’s Bankers without Borders program, which engages volunteer consultants to donate their expertise to serve social enterprises and nonprofits in poor countries. For more information, visit: https://www.bankerswithoutborders.com.