Cross-border retail banking

Cross-border retail banking - direct lending to and depositing from non-bank customers - had increased rapidly before the global financial crisis. Cross-border claims to foreign non-bank customers dominated the cross-border banking activities of banks with a share of about 41 per cent by mid 2012, thus even exceeding the share of claims that these banks had with related banks abroad (about 30 per cent). Likewise, the share of liabili- ties to the private non-bank sector abroad (about 43 per cent) exceeded the liabilities to all other foreign sectors. This dominant role emerged towards the end of the twentieth century. Direct cross-border loans and deposits to non-banks as a major part of all cross- border claims and liabilities with non-banks alone accounted for a market share of about one-third (see Sander and Kleimeier, 2013).

Despite the above-documented globalization, it would be premature to declare the "death of distance" in cross-border retail banking (see Degryse and Ongena, 2005). This is especially true for cross-border loans, which suffer from information asymmetry and monitoring problems that are likely to be intensified in a global context where borders matter and differences in regulation are substantial. In this sense, Sander et al. (2013) provide evidence that "deep" regional integration agreements such as the European Union, which homogenizes regulation, promote cross-border lending while other, less deep regional integration schemes do not. As cross-border deposits suffer less from asym- metric information, the major drivers are substantial interest rate differences and regula- tory arbitrage, as customers want to take advantage of differences in deposit insurance systems, taxation and reporting to the home country tax authorities (see, for instance, Huizinga and Nicodème, 2004, 2006). But differences in financial market efficiency also play an important role (see for example Alworth and Andresen, 1992), while regional free trade agreements as well as common currency arrangements can facilitate and support such cross-border depositing activities (Sander et al., 2013).

Cross-border retail banking offers a number of benefits to banks and their customers. Next to international diversification benefits for both, it can insure bank customers against financial crises at home, be it by depositing abroad or via access to foreign bank loans in times of a domestic credit crunch. Banks can insure themselves with cross-border lending and cross-border funding against crises originating in the domestic real sector. But these benefits come with the cost of a potential vulnerability to foreign shocks. While bank customers are especially vulnerable to foreign financial crises, banks face risks emanating from crises in the foreign real sector. In case of substantial foreign exposures this increases the risk for crisis contagion across countries. Moreover, borrowers in customer countries expose themselves to currency risks when borrowing in foreign currency abroad, the so-called "original sin" problem. As domestic financial crises and currency crises often occur as twin crises, the insurance benefits from borrowing abroad can easily be (over-) compensated by foreign-exchange losses that increase the debt burden meas- ured in local currency.

Financial crises in bank countries can lead to a reduction in direct cross-border lending (see for instance Cetorelli and Goldberg, 2010; Ivashina and Scharfstein, 2010). On the other hand, one would expect that (frequent) financial crises in customer coun- tries would stimulate more foreign borrowing to insure against such crises. However, Kleimeier et al. (2013) find evidence for such a response only for currency crises and not for banking crises, except for the 2008-09 global financial crisis. In contrast, depositors are found to respond to domestic financial crises by internationalizing their deposit holding. In this sense, previous financial crises have been a driver of retail banking glo- balization. If, however, financial crises occur in both the bank country and the customer country at the same time, such as in a global financial crisis, the benefits of cross-border banking can evaporate quickly, leaving banks and depositors with only the costs and no safe havens.

Cross-border retail banking is only one way in which banks can reach foreign customers. It is part of what has been called the "international model of global banking" as opposed to the "multinational model of global banking", where banks reach custom- ers indirectly through foreign subsidiaries and branches, which some observers evaluate more positively in terms of global financial stability (see McCauley et al., 2010). It should be kept in mind, however, that the "international model" includes the global wholesale funding of banks, which was a crucial factor leading to the global financial crisis (see Shin, 2012), while the "multinational model" can also expose customers to severe exter- nal risks (De Haas and Van Horen, 2013). Nevertheless, the fact that cross-border retail banking has even increased its share in global banking during and since the global finan- cial crisis indicates that it is still attractive and requires the close attention of researchers and policy makers alike.

See also:

Asymmetric information; Contagion; Currency crisis; Financial crisis.