Did Foreign Banks ‘Cut And Run’ Or Stay Committed To Emerging Europe During The Crises?

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Did Foreign Banks ‘Cut And Run’ Or Stay Committed To Emerging Europe During The Crises?

Did Foreign Banks ‘Cut And Run’ Or Stay Committed To Emerging Europe During The Crises?

John Bonin

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Wesleyan University – Economics Department

Dana Louie

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Wesleyan University

October 2015

Abstract:

Our objective is to examine empirically the behavior of foreign banks regarding real loan growth during a financial crisis for a set of countries in which these banks dominate the banking sectors due primarily to having taken over large existing former state-owned banks. The eight countries are among the most developed in Emerging Europe, their banking sectors having been modernized by the beginning of the time period. We consider a data period that includes an initial credit boom (2004-2007) followed by the global financial crisis (2008 & 2009) and the onset of the Eurozone crisis (2010). Our main innovations with respect to the existing literature on banking during the financial crisis are to include explicit consideration of exchange rate dynamics and to separate foreign banks into two categories, namely, subsidiaries of the Big 6 European MNBs and all other foreign-controlled banks. Our results show that bank lending was impacted adversely by the crisis but that the two types of foreign banks behaved differently. The Big 6 banks remained committed to the region in that their lending behavior was not different from that of domestic banks corroborating the notion that these countries are a “second home market” for these banks. Contrariwise, the other foreign banks were primarily responsible for fueling the credit boom prior to the crisis but then “cut and ran” by decreasing their lending appreciably during the crisis. Our results also indicate different bank behavior in countries with flexible exchange rate regimes from those in the Eurozone. Hence, we conclude that both innovations matter in empirical work on bank behavior during a crisis in the region and may, by extension, be relevant to other small countries in which banking sectors are dominated by foreign financial institutions.

Did Foreign Banks ‘Cut And Run’ Or Stay Committed To Emerging Europe During The Crises?

Not All Foreign Banks are the Same

The European countries that either emerged from the shadow of the Warsaw Pact after the fall of the Berlin Wall or were created from provinces seceding from the Yugoslav Federation looked westward to the European Union (EU) with aspirations to become members as quickly as possible. A crucial aspect of this integration would be the development of modern financial systems from banking sectors that had been subservient to the government planning bureaucracy in many of the countries. Over approximately a decade, most of the state-owned banks in the region, which is commonly referred to as Central, Eastern, and Southeastern Europe (CESE) by the IMF, were privatized eventually to mainly majority foreign financial institutions. In addition, foreign banks set up greenfield operations in these countries and new domestic banks were born as entry requirements were relaxed to engender competition at the beginning of the economic transformation. Foreign banks brought expertise and technology to a backward sector in need of rapid modernization. At the beginning of the new millennium, foreign banks dominated the banking sectors of most CESE countries having asset shares as a group of over 40% in all but one of the eleven countries that would become part of the EU in the subsequent decade. Indeed, foreign banks had assets shares of over 65% in seven of these countries by 2000.

Foreign dominance of the banking sectors is not the only special characteristic of these eleven countries. Due partly to mergers and acquisitions among parent banks, the landscape became dominated by seven multinational European banks. Swedbank is the dominant foreign bank in all three Baltic countries that are now members of the EU. Six banks, namely Raiffeisen and Erste (Austria), Intesa Sanpaolo and UniCredit (Italy), Societe Generale (France) and KBC (Belgium), are active in the other eight new EU member countries. Bonin (2010) and Epstein (2014) argue that these six banks treat the region as a second home market having staked reputational capital on the success of their subsidiaries in the host countries. This commitment to the region was tested recently during both the global financial crisis (GFC) and the Eurozone crises (EZC). The reaction of these banks to both crises provides important evidence for the general discussion of the net benefit of foreign takeover of banking sectors in small countries.

Foreign Banks

The empirical literature treats all foreign banks in the region alike by incorporating them into a dummy variable for banks with controlling foreign ownership. In this paper, we recognize the special character of the six multinational European banks (Big 6) operating in some or all eight new EU member countries (EU 8), namely, Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Slovakia, and Slovenia. Our focus is on the time period immediately preceding the GFC through the onset of the EZC in 2010. We consider three sub-periods: first a credit boom that continues from 2004 to 2007 in all countries, followed by the GFC in 2008 and 2009, and finally the initial effects of the EZC in 2010. The credit boom was essentially fueled by all banks’ desire to take advantage of the nascent and profitable retail credit markets in these countries, including home mortgage business. Much of the funding for this lending came from wholesale markets or through the internal capital markets of the large banks. The GFC provided a stress test for this business model. In addition, the EU 8 were buffeted by a second shock when the Greek crisis exploded in 2010 leading to the EZC. Empirical work attempting to discern the role played by foreign banks in the region during the crisis period basically concluded that foreign banks reduced lending during crisis years more than their domestic counterparts. However, by failing to distinguish between the Big 6, which as a group were the dominant foreign presence in most countries, and other foreign banks, in particular Greek banks that were active in the southern countries, the literature conflates two different business models.

Foreign Banks

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