Does Government Intervention Affect Banking Globalization?

1. Does Government Intervention Affect Banking Globalization? Anya Kleymenova,1 Andrew K. Rose2 and Tomasz Wieladek3 1 Chicago-Booth 2 Berkeley-Haas, ABFER, CEPR and NBER 3 Barclays Capital, ex Bank of England Disclaimer: The research presented here solely reflects the views of the authors and not those of the Bank of England.

2. Motivation (I) • Global financial crisis of 2007-2009 led to a decrease in global bank lending but not in portfolio and bond flows • Potential explanations include: • Rise in financial regulation • Weakness in loan demand • Political interference

3. Motivation (II) • Cross-border bank lending fell by an unprecedented amount Stock of Foreign Assets by Type Sources: BIS and IFS

4. Motivation (III) • Simultaneously: large public sector financial interventions in system around the world Public Capital Injections as a Fraction of 2008 GDP Source: IMF

5. Motivation (IV) • Rose and Wieladek (2014) show that one possible explanation is “financial protectionism” • Increase in home bias following government intervention • Objective here: provide more evidence of financial protectionism

6. Financial Protectionism • Public financial intervention  nationalistic change in banks’ behaviour • Discrimination between domestic and foreign borrowers and depositors (greater home bias) • Convergence of bank preferences for lending abroad

7. Anecdotal Evidence • Germany • Commerzbank Nov 2008 public capital injection was conditional on lending to Mittelstand (German SMEs) • UK • Project Merlin encouraged more domestic lending (in particular to SMEs) • US • TARP banks were supposed to raise capital ratios and maintain or increase domestic lending • The only way to meet these inconsistent goals was to cut back foreign lending (unintended consequence)

8. Three Research Questions • Do banks’ preferences for domestic vs. foreign lending/ deposits change when they experience a large public intervention? (Analogue to existing asset work, but liabilities.) • Test using UK data (depth) • Does this lead to a similar cross-country portfolio allocation by nationalized banks from the same country? • Test using UK data (breadth) • Does this change in geographic asset allocation persist after the intervention ends? • Test using US TARP entry and exits (persistence)

9. Question 1 Do banks’ preferences for domestic vs. foreign liabilities change with nationalization? Is there a liability effect similar to (already observed) asset effect? • Compare before/after nationalizations • Panel Approach with many private banks, fixed bank and time effects • Hence difference in difference methodology

10. Empirical approach: Depth Fori,t/(Domi,t+Fori,t) = αi + βt + γFORNatFOR,i,t + γUKNatUK,i,t+ θFORLLFOR,i,t + θUKLLUK,i,t+ζFORCapFOR,i,t + ζUKCapUK,i,t+ εi,t, Fori,t – lending to (borrowing from) foreign residents by bank i at time t; Domi,t– lending to (borrowing from) domestic (British) residents by bank i at time t; αi – bank-specific fixed effects; βt – time fixed effects; NatFOR,i,t = 1 if a foreign bank is nationalized at or before time t, 0 otherwise; NatUK,i,t = 1 when a British bank i is nationalized at or before time t, and 0 otherwise; LLi,t , Capi,t – analogues for banks that receive unusual access to liquidity or loan guarantees (LL), or are the recipients of public capital injections (Cap); and εi,t – well-behaved disturbance term.

11. Depth and Breadth: Data • Confidential Bank of England dataset • Comprehensive balance sheet information for all banks operating in the UK (1999Q1 – 2011Q4) • Used for regulatory purposes and national account statistics • Covers 334 banks, 53 are UK-owned • A large number of banks do both domestic and cross-border lending • Total number of observations is 11,544 • Hand-collected public interventions • Includes access to liquidity insurance facilities, public capital injections and nationalizations

12. Results (Depth) • Foreign bank nationalization raises the mix of foreign to total assets by around 15% • Foreign bank nationalization increases the fraction of foreign liabilities by 14% •  Consistent with financial protectionism • Results are robust to: • Treatment of outliers • Bank size • Inclusion of bank controls • Inclusion of random effects

13. Sensitivity Analysis

14. More Sensitivity Analysis

15. Summary: Big Depth Effect • Bank nationalization of non-British banks tilts composition of bank balance sheets away from British to foreign activity, for both assets and liabilities • Prima Facie evidence of Financial Protectionism • Strong statistically and economically, insensitive, similar asset and liability magnitudes

16. Empirical approach: Breadth • Do government interventions also affect ­cross-country breadth of banking globalization? • Do officials who take charge of any given nationalized bank divest in a similar fashion? • Do portfolios of nationalized banks grow alike? • Does a given bank’s cross-country portfolio mix converge (to resemble the portfolio of other nationalized banks) or diverge in the wake of nationalization?

17. Question 2 Do banks’ cross-country asset portfolios change systematically with nationalization? Compare pair of banks before/after nationalizations. • One bank nationalized • Two banks nationalized from different countries • Two banks nationalized from same country • Panel Approach with many bank-pairs, fixed dyad and time effects • Again, difference in difference methodology

18. Simple Example • HSBC: British bank with substantial Asian operations • Yorkshire Bank: subsidiary of National Australia Bank, specializes in UK mortgages, little overseas • Similarity of overseas portfolios of HSBC and YB likely to be limited • Q: if both HSBC and YB were nationalized, would their foreign portfolios converge?

19. Measurement of Similarity • Cosine Similarity • COSAi,I,t ≡ [ΣkAssets(k)i,t∙Assets(k)j,t] {[Σk(Assets(k)i,t)2].5} ● {[Σk(Assets(k)j,t)2].5} • Varies between 0 and 1 • Assets(k)i,tdenotes Assets bank i holds in country k at time t, taken from the CC1 form of the Bank of England • Typical resident UK bank lends to average of 53 countries • We require i and j share at least 30 countries

20. Histogram of Cosine Similarity

21. Estimation Equation: Breadth COSAi,j,t = αi,j + βt + γOneNati,j,t + ψBothNati,j,t + φSCBothNati,j,t+ vi,j,t COSAi,j,t – cosine similarity of foreign assets (across countries) for a pair of banks i and j at time t; αi,j– comprehensive set of dyadic bank pair-specific fixed effects; βt– time fixed effects; OneNati,j,t = 1 if either bank i or bank j (but not both) is nationalized at or before time t; BothNati,j,t = 1 if both bank i and bank j are nationalized at or before time t; SCBothNati,j,t =1 if both bank i and bank j are nationalized at or before time t and both banks are from the same country; and vi,j,t– omitted factors determining the similarity of the cross-country portfolio mix for a pair of banks.

22. Effect of Nationalization of OneBank on Cosine Similarity • Cosine similarity of foreign assets (CSFA) of pair of banks: • Not expected to change if causes of bank nationalization independent of cross-country exposures mix • But suppose sub-prime losses in US caused GFC? • CSFA would change similarly for all banks • So include comprehensive time effects

23. What if Both Banks Nationalized? • If governments have different preferences for cross-country assets: • Country x divests from a,b,c, invests in d,e,f • Country y has opposite preferences • CSFA falls if banks from different countries (xy) • CSFA rises if banks from same country (xx/yy) • 55 observations • 354 observations where both banks nationalized

24. Results • Single bank nationalization has little detectable effect (γ) • When both banks are nationalized, the similarity of banks’ cross-country portfolio mixes falls significantly (ψ) • Opposite effect if nationalized banks from same country(φ)

25. Insensitive Results

26. More Sensitivity Analysis

27. Summary: Big Breadth Effect • When pair of banks from same country nationalized, cross-country asset portfolios converge; financial globalization shrinks • Nationalized banks in different countries: opposite • Prima Facie evidence of financial protectionism • Strong statistically and economically, insensitive

28. Question 3 Does banks’ preferences for domestic vs. foreign assets persist after intervention ended? • Compare before/after TARP and reversal • Panel Approach with many banks, fixed bank and time effects • Still again, difference in difference methodology

29. Empirical Approach: Persistence Yi,t = αi + βt + γTARPEntryi,t + θTARPExiti,t + εi,t Yi,t– growth rate of domestic household, commercial and industrial/foreign lending; αi – comprehensive set of bank-specific fixed effects; βt – set of time fixed effects; TARPEntryi,t = 1 when bank i receives TARP funds at or before time t and 0 otherwise; TARPExiti,t= 1 when bank i repays TARP funds at or before time t and 0 otherwise; and εi,t – well behaved disturbance term. • We estimate our default model for banks with assets in the top 5% of the asset distribution • We use growth rates rather than levels as growth rates are almost normally distributed (and many American banks have no foreign activity)

30. Persistence: Data • FR Y-9C and US Treasury • US Bank Holding Companies (BHCs) participating in TARP (1991Q1-2012Q4) • Main analysis uses large banks (5% of assets distribution, 75 banks on average) • 2,981 observations are large banks with foreign lending (35 banks on average) • Robustness tests show results for the full sample of banks

31. Persistence: Results • Negative and significant effect on foreign loan growth rate upon banks’ entry into TARP • The effect appears to reverse upon banks’ exit from TARP, but poor precision • Results are robust to various specifications • In large: results reasonably weak; poor precision for almost all coefficients, small economic sizes

32. Sensitivity Analysis

33. Results: Persistence • Using our results we construct a counterfactual of aggregate foreign lending without TARP • Following entry into TARP aggregate foreign lending decreased by 16.8%. • This decrease would have been 3.3% lower in the absence of TARP. • Without TARP, the rebound in foreign lending would have been faster

34. Summary: Weak Persistence Effect • Effect of TARP on domestic vs. foreign lending growth simply too weak to have much confidence • Small effects both economically and statistically

35. Conclusions • Government interventions influence both sides of banks’ balance sheets • We find evidence consistent with effects on the depth of the asset and funding side: foreign nationalized banks in the UK discriminate against UK borrowers and UK lenders. • Banks’ cross-country asset allocations converge following nationalization, likely reflecting government preferences • We find evidence of similarities in portfolio allocations of nationalized banks from same country, opposite from different countries (breadth is affected). • 1 and 2 supportive of financial protectionism • This effect might wear off once government support is withdrawn • We find evidence effects erode following banks’ exit from TARP, but statistical results are weak. • So financial protectionism effects might not be persistent.