Capital Flows, Cross-Border Banking and Global Liquidity Valentina Bruno

Hyun Song Shin

December 2012

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Main Themes • Global financial conditions closely intertwined with cross-border banking • Global factors drive capital flows into diverse destination countries

• US dollar as currency underpinning cross-border banking • European banks as intermediaries in cross-border banking

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

Trillion dollars

Net interoffice assets Borrowings from others Cash assets

2

Large time deposits Securities

Borrowings from banks in U.S. Loans and leases

2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5

23-Nov-11

11-May-11

27-Oct-10

14-Apr-10

30-Sep-09

18-Mar-09

03-Sep-08

20-Feb-08

08-Aug-07

24-Jan-07

12-Jul-06

28-Dec-05

15-Jun-05

01-Dec-04

19-May-04

05-Nov-03

23-Apr-03

09-Oct-02

27-Mar-02

12-Sep-01

28-Feb-01

16-Aug-00

02-Feb-00

21-Jul-99

06-Jan-99

-2.0

Figure 1. Assets and liabilities of foreign banks in the U.S. (Source: Federal Reserve H8 weekly series on assets and liabilities of foreign-related institutions)

Billion dollars

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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800

600

400 Net interoffice assets of foreign banks in US 200

0

-200

30-Nov-11

03-Nov-10

07-Oct-09

10-Sep-08

15-Aug-07

19-Jul-06

22-Jun-05

26-May-04

30-Apr-03

03-Apr-02

07-Mar-01

09-Feb-00

13-Jan-99

17-Dec-97

20-Nov-96

25-Oct-95

28-Sep-94

01-Sep-93

05-Aug-92

10-Jul-91

13-Jun-90

17-May-89

20-Apr-88

-400

Figure 2. Net interoffice assets of foreign banks in U.S. given by negative of Federal Reserve weekly H8 series on “net due to related foreign offices of foreign-related institutions”

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

(%)

4

90 80 Asia

70 60

United States 50 40

Other Europe

30 20

Other euro area

10 2011 H1

2010 H2

2010 H1

2009 H2

2009 H1

2008 H2

2008 H1

2007 H2

2007 H1

2006 H2

0

Belgium, Italy, Spain, Portugal, Ireland, Greece

Figure 3. Amount owed by banks to US prime money market funds (% of total), based on top 10 prime MMFs, representing $755 bn of $1.66 trn total prime MMF assets (Source: IMF GFSR Sept 2011, data from Fitch).

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Trillion Dollars

Impact on US Financial Conditions 2.0

Liabilities: Foreign official assets in United States (line 56)

1.5 Liabilities: Foreign claims on U.S. non-banks (line 68) 1.0

-0.5

Liabilities: Foreign claims on U.S. banks and securities brokers (line 69) Liabilities: Foreign private holding of U.S. securities other than Treasurys (line 66) Assets: US holding of foreign securities (line 52)

-1.0

Assets: Claims of U.S. nonbanks on foreigners (line 53)

0.5 0.0

2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991

-1.5

Assets: Claims of U.S. banks and securities brokers on foreigners (line 54)

Figure 4. US gross capital flows by category (Source: US Bureau of Economic Analysis). Increase in US liability to foreigners is indicated by positive bar, increase in US claims on foreigners is indicated by negative bar.

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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European Global Banks Shadow banking system

US Borrowers

Wholesale funding market

US Banking Sector

US Households

border Figure 5. European global banks add intermediation capacity for connecting US savers and borrowers

Trillion Dollars

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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7.0 6.0 5.0

Non-European BIS reporting countries

4.0

Other European BIS reporting countries Switzerland

3.0

United Kingdom

2.0 France

1.0 Germany

2010-Q4

2010-Q2

2009-Q4

2009-Q2

2008-Q4

2008-Q2

2007-Q4

2007-Q2

2006-Q4

2006-Q2

2005-Q4

2005-Q2

0.0

Figure 6. Foreign claims of BIS reporting banks on US counterparties (Source: BIS consolidated banking statistics, Table 9D)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Borrowers in A

Banks in A

Borrowers in B

Banks in B

Global Banks

Wholesale Funding Market

Banks in C

Borrowers in C

Figure 7. Topography of global liquidity

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Borrowers in A

Banks in A

Borrowers in B

Banks in B

Global Banks

Wholesale Funding Market

Banks in C

Borrowers in C

Figure 8. Topography of global liquidity

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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500 Dec 2008

450

Ireland

400

Spain

350

Turkey

300

Australia

250

South Korea

200

Chile

Mar 2003 =100

150

Brazil

100

South Africa

50 Dec.2011

Mar.2011

Jun.2010

Sep.2009

Dec.2008

Mar.2008

Jun.2007

Sep.2006

Dec.2005

Mar.2005

Jun.2004

Sep.2003

Dec.2002

Mar.2002

Jun.2001

Sep.2000

Dec.1999

Mar.1999

0

Figure 9. Cross-border claims (loans and deposits) of BIS reporting banks on counterparties listed on right (Source: BIS locational banking statistics Table 7A)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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3,000

2,500

2,000

Latvia

1,500

Lithuania

1,000

Estonia

500

Iceland 100

Dec.2011

Mar.2011

Jun.2010

Sep.2009

Dec.2008

Mar.2008

Jun.2007

Sep.2006

Dec.2005

Mar.2005

Jun.2004

Sep.2003

Dec.2002

Mar.2002

Jun.2001

Sep.2000

Dec.1999

Mar.1999

0

Figure 10. Cross-border claims (loans and deposits) of BIS reporting banks on counterparties listed on right (Source: BIS locational banking statistics Table 7A)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

Outline • “Double-decker” model of credit supply — Global banks and local banks — Capital flows through banking sector • Bank credit supply — Leverage tied to risk measures (VIX, VaR) — Deviation from standard portfolio rules • Empirical hypotheses and investigation

12

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

Corporate Finance of Banking

A

L Equity

Assets Debt

13

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

A

L

14

A

L Equity

Equity Assets

Assets Debt

Debt

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

A

L

15

A

Equity

L Equity

Assets Debt

Assets Debt

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Barclays: 2 year change in assets, equity, debt and risk-weighted assets (1992 -2010)

2 year change in equity, debt and risk-weighted assets (billion pounds)

1,000 800 y = 0.9974x - 0.175 R2 = 0.9998

600

2yr RWA Change

400 200

2yr Equity Change

0 -200

2yr Debt Change

-400 -600 -800 -1,000 -1,000

-500

0

500

1,000

2 year asset change (billion pounds)

Figure 11. Barclays: 2 year change in assets, equity and debt (1992-2010) (Source: Bankscope)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Turning Credit Risk Model on Its Head • Vasicek one factor credit risk model (backbone of Basel) • Turn Vasicek model on its head as credit supply model — Fix E. Determine credit supply S

E , S= 1+r 1 − 1+f ϕ (ρ, α, ε)

ϕ ∈ (0, 1)

ϕ is ratio of notional debt to notional assets [ϕ is normalized leverage measure, with ϕ ∈ (0, 1)]

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Credit Supply

Notation for balance sheet of bank Bank

E

1+ r

C

1+ f

L

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Vasicek (2002) extension of Merton (1974) to allow for many borrowers j

Project value

V (0 )

F default probability

0

0

t T

Figure 12. Value of projects of local borrowers and default probability

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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√ s2 µ− T + s T Wj 2

VT = V0 exp 

2



s ln (V /F ) + µ − 0 2 T  √ Prob (VT < F ) = Φ Wj < −  s T

= Φ (−dj ) Vasicek (2002):

√ Wj = ρY +

1 − ρXj

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Borrower j repays the loan when Zj ≥ 0, where Zj is the random variable: Zj

√ ρY + 1 − ρXj √ −1 = −Φ (ε) + ρY + 1 − ρXj = dj +

Realized value of assets at date 1 w (Y ) ≡ (1 + r) C · Pr (Zj ≥ 0|Y ) √ = (1 + r) C · Pr ρY + 1 − ρXj ≥ Φ−1 (ε) |Y = (1 + r) C · Φ

Y

√ ρ−Φ−1(ε) √ 1−ρ

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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22

15 ρ = 0.3

ε = 0.2

8

density over realized assets

density over realized assets

10

ε = 0.1

6 4 ε = 0.2 2 0

12

ρ = 0.01

9

6

ρ = 0.1

3

ε = 0.3 0

0.2

ρ = 0.3

0.4

0.6 z

0.8

1

0

0

0.2

0.4

0.6

0.8

1

z

Figure 13. The two charts plot the densities over realized assets when C (1 + r) = 1. The left hand charts plots the density over asset realizations of the bank when ρ = 0.1 and ε is varied from 0.1 to 0.3. The right hand chart plots the asset realization density when ε = 0.2 and ρ varies from 0.01 to 0.3.

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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c.d.f. of w F (z) = Pr (w ≤ z)

= Pr Y ≤ w−1 (z)

= Φ w−1 (z)  √ −1 −1 Φ (ε) + 1 − ρΦ  = Φ √ ρ

z (1+r)C

  

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Bank Behavior Value-at-Risk (VaR) rule with insolvency probability to α > 0 when notional liability is (1 + f) L. Private credit C determined from Pr (w < (1 + f ) L) = Φ

√ (1+f )L Φ−1(ε)+ 1−ρΦ−1 (1+r)C √ ρ

=α

√ −1 ρΦ (α) − Φ−1 (ε) Notional liabilities (1 + f ) L √ = =Φ Notional assets (1 + r) C 1−ρ where ϕ (α, ε, ρ) ≡ Φ

√ −1 ρΦ (α)−Φ−1(ε) √ 1−ρ

(1)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Supply of Credit Credit supply C and demand for funding L is obtained from (1) and balance sheet identity C = E + L C=

E 1+r 1 − 1+f ·ϕ

,

L=

1+f 1+r

E · ϕ1 − 1

Aggregation holds due to proportionality Leverage =

1 1+r 1 − 1+f ·ϕ

Risk premium is well-defined Risk premium = (1 − ε) (1 + r) − 1

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Double-decker model of Global Liquidity

Global Bank

Regional Bank

ER

1+ r

C

EG 1+ f

L

L

Figure 14. Regional and global bank balance sheets

1+ i

M

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Regional bank in k

Diversified loan portfolio across regional banks

Diversified loan portfolio from region k

j

Borrower j in region k Borrowers

Regions

k Figure 15. Global and regional banks

Global bank

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Global, Regional and Idiosyncratic Risk Factors

Zkj ≡ −Φ−1 (ε) + Yk =

√ ρYk +

βG +

Regional bank k defaults when Yk < w−1 ((1 + f ) L) =

√1 ρ

1 − ρXkj

1 − βRk

Φ−1 (ε) +

1 − ρΦ−1 (ϕ)

Or when ξ k < 0 ξk

√ ≡ ρYk − Φ−1 (ε) − =

ρβG +

1 − ρΦ−1 (ϕ)

ρ (1 − β)Rk − Φ−1 (ε) −

1 − ρΦ−1 (ϕ)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Asset realization is deterministic function of global risk factor G w (G) = (1 + f) L · Pr (ξ k ≥ 0|G) = (1 + f) L · Pr Rk ≥ = (1 + f) L · Φ

√ Φ−1(ε)+ 1−ρΦ−1(ϕ) √ ρ(1−β)

β 1−β G

−

−

√ Φ−1 (ε)+ 1−ρΦ−1(ϕ) √ ρ(1−β)

Quantiles follow from the c.d.f. of w (G). F (z) = Pr (w (G) ≤ z)

= Pr G ≤ w−1 (z)

= Φ w−1 (z)

β 1−β G

G

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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where w

−1

(z) =

1−β β

Φ

−1

z (1+f )L

+

√ Φ−1(ε)+ 1−ρΦ−1 (ϕ) √ ρ(1−β)

Global bank Value-at-Risk (VaR) rule with insolvency probability γ > 0. Notional liability of the global bank is (1 + i) M . γ

= Pr (w (G) < (1 + i) M ) = Φ

1−β β

Φ

−1

(1+i)M (1+f )L

+

√ Φ−1(ε)+ 1−ρΦ−1 (ϕ) √ ρ(1−β)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

Notional liabilities Notional assets

=

(1 + i) M (1 + f ) L

= Φ

√ √ ρβΦ−1 (γ)−Φ−1 (ε)− 1−ρΦ−1(ϕ) √ ρ(1−β)

≡ ψ (γ, α, β, ε, ρ) Cross-border loan supply

EG L= 1 − 1+f 1+i ψ

31

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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f

LD ( f ) 1+i ψ

−1

ϕ (1 + r ) − 1 LS ( f )

α / (1 − α ) 0

EG

1−

ψ (1 − α )(1 + i )

Figure 16. Equilibrium cross-border lending L

L

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

Capital Flows and Domestic Credit Market clearing for L ER EG = 1+f 1 1+f · − 1 1 − 1+r ϕ 1+i ψ Private credit

C=

EG + ER 1 − 1+r 1+i ϕψ

Aggregate bank capital (regional + global) Total private = credit regional global 1 − spread × × leverage leverage

33

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

Risk premium in recipient economy π ≡ (1 − ε) (1 + r) − 1 Equilibrium stock of cross-border lending L

L=

EG + ER · 1+r 1+i ϕψ 1 − 1+r 1+i ϕψ

Global and weighted regional bank capital Total cross= border lending regional global 1 − spread × × leverage leverage

34

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Comparative Statics Global factors EG and ψ ∆L ≃

∂L ∂L ∆EG + ∆ψ ∂EG ∂ψ

=

1 ∆EG + 1 − ϕψ

(1 − ϕψ) ERϕ − (EG + ERϕψ) (−ϕ)

=

ϕ 1 ∆EG + C ∆ψ 1 − ϕψ 1 − ϕψ

2

(1 − ϕψ)

∆ψ

Banking sector capital flows (i) increase with ∆EG (ii) increase with bank leverage (iii) increase in change in bank leverage

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Impact of Currency Appreciation Local bank

Local borrower

A

L

Local currency

US dollars

1+ r

A

L

US dollars

US dollars

1+ f Global bank

border

Figure 17. Local non-bank borrowers have currency mismatch

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Impact of Currency Appreciation Project value

Effect of currency appreciation

F default probability

0

0

t T

Figure 18. Currency appreciation lowers probability of default ε

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Empirical Counterparts 35.0

Leverage ( =(total liabilities + equity)/equity)

2007Q2

30.0

25.0

20.0

15.0 2009Q1

10.0

2012Q1

2011Q1

2010Q1

2009Q1

2008Q1

2007Q1

2006Q1

2005Q1

2004Q1

2003Q1

2002Q1

2001Q1

2000Q1

1999Q1

1998Q1

1997Q1

1996Q1

1995Q1

1994Q1

1993Q1

1992Q1

1991Q1

1990Q1

5.0

Figure 19. Leverage of US Securities broker dealer sector (Source: Federal Reserve Flow of Funds)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Leverage and VIX 35.0

BD leverage

30.0

25.0

20.0

15.0

10.0 2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

3.6

3.8

4.0

log_vix(-1)

Figure 20. Scatter chart of broker-dealer leverage and lagged log VIX

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Table 1. Broker dealer leverage and VIX. This table presents OLS regressions with broker dealer leverage as the dependent variable and the one-quarter lagged log VIX index as the explanatory variable. Column 2 includes the post-crisis dummy that takes the value 1 after 2007Q4 and zero otherwise.

VIX(-1)

1

2

-0.058***

-0.031***

[0.000]

[0.008]

Post-crisis dummy

-0.059*** [0.000]

Constant

Observations 2 R 2 Adjusted R

0.379***

0.312***

[0.000]

[0.000]

64

64

0.20

0.471

0.187

0.453

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Two Sets of Panel Regressions Set 1: US broker dealer leverage as proxy for global banks’ leverage ∆Lc,t = β 0 + β 1 · ∆Interofficet + β 2BD Leveraget−1 + β 3 · ∆BD Leveraget +β 4∆Equityc,t + β 5∆RERt−1 + controlsc,t + ec,t

Set 2: VIX as proxy for global banks’ leverage (include residual of BD leverage regression on VIX as a check) In both cases, gauge relative impact of global versus local variables

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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500 Dec 2008

450

Ireland

400

Spain

350

Turkey

300

Australia

250

South Korea

200

Chile

Mar 2003 =100

150

Brazil

100

South Africa

50 Dec.2011

Mar.2011

Jun.2010

Sep.2009

Dec.2008

Mar.2008

Jun.2007

Sep.2006

Dec.2005

Mar.2005

Jun.2004

Sep.2003

Dec.2002

Mar.2002

Jun.2001

Sep.2000

Dec.1999

Mar.1999

0

Figure 21. Cross-border claims (loans and deposits) of BIS reporting banks on counterparties listed on right (Source: BIS locational banking statistics Table 7A)

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity VIX

0.25

70

0.20

60

0.15 50 0.10 0.05

40

0.00

30

-0.05

VIX Index (average over quarter)

Banking Sector Capital Flows (year on year growth of external claims of BIS-reporting banks)

Banking sector capital flows

43

20 -0.10 10

-0.15 Sep-11 Dec-10 Mar-10 Jun-09 Sep-08 Dec-07 Mar-07 Jun-06 Sep-05 Dec-04 Mar-04 Jun-03 Sep-02 Dec-01 Mar-01 Jun-00 Sep-99 Dec-98 Mar-98 Jun-97 Sep-96

-0.20

0

Figure 22. This figure plots cross-border banking sector capital flows as year-on-year growth in external claims of BIS-reporting banks (Table 7A). The VIX series is the quarterly average of CBOE VIX index.

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

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Sample Sample of 46 countries with largest foreign bank penetration (Claessens, van Horen, Gurcanlar and Mercado (2008)) Argentina, Australia, Austria, Belgium, Brazil, Bulgaria, Canada, Chile, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Indonesia, Ireland, Israel, Italy, Japan, Latvia, Lithuania, Malaysia, Malta, Mexico, Netherlands, Norway, Poland, Portugal, Romania, Russia, Slovakia, Slovenia, South Korea, Spain, Sweden, Switzerland, Thailand, Turkey, Ukraine, United Kingdom and Uruguay.

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

45

Summary Statistics Variable Dependent Variable ∆Loan Global Variables ∆Interoffice VIX BD Leverage ∆Equity Local Variables ∆RER ∆M2 GDP growth Debt to GDP Inflation Stock volatility Bank ROA

Frequency

Obs

Mean

Std. Dev.

Min

Max

Quarter

2944

0.025

0.090

-0.172

0.240

Quarter Quarter Quarter Annual

64 64 64 14

0.087 3.045 0.203 0.131

0.515 0.347 0.046 0.219

-1.362 2.433 0.124 -0.266

1.908 3.787 0.304 0.697

Quarter Annual Annual Annual Annual Annual Annual

2942 532 532 532 532 465 465

-0.002 0.135 0.080 0.517 0.046 3.213 0.007

0.068 0.152 0.078 0.284 0.054 0.425 0.011

-0.510 -0.253 -0.208 0.067 -0.004 2.195 -0.041

1.030 1.413 0.607 1.272 0.365 4.705 0.026

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity 1

∆Interoffice(-1)

2

3

0.5485*** [0.000]

0.0048 [0.137] 0.5487*** [0.000]

0.0065** [0.048] 0.4091*** [0.000]

0.2067*** [0.000]

0.1900*** [0.000]

0.1793*** [0.000]

0.0301*** [0.002]

0.0272*** [0.004]

0.0179*** [0.000]

BD Leverage(-1)

∆BD Leverage

46

∆Equity ∆RER(-1)

4

5

-0.1452*** [0.000]

-0.1502*** [0.000]

-0.0892*** [0.005] 0.0421** [0.036] 0.0576 [0.290] -0.0286 [0.173] -0.1755* [0.069] 0.0049 [0.588] 1.4313*** [0.000] -0.0734* [0.060] 2,020 0.176 44

∆M2(-4)

Observations

0.0237*** [0.000] 2,944

-0.0855*** [0.000] 2,944

-0.0905*** [0.000] 2,576

0.0251*** [0.000] 2,942

0.0586** [0.021] 0.1122* [0.093] -0.0066 [0.718] -0.2278** [0.044] -0.0295*** [0.000] 1.5050*** [0.000] 0.1082*** [0.000] 2,020

R # countries

0.011 46

0.097 46

0.112 46

0.013 46

0.113 44

GDP growth(-4) DEBT/GDP(-4) Inflation(-4) Stock volatility(-4) Bank ROA(-4) Constant

2

6

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

∆Interoffice(-1) VIX(-1)

∆VIX ∆Equity ∆Equity∗VIX(-1)

47

1

2

3

4

5

6

0.0126*** [0.001] -0.0719*** [0.000] -0.0303*** [0.000] -0.0272*** [0.002]

0.0140*** [0.000] -0.0533*** [0.000] -0.0214*** [0.002] 0.3492** [0.013] -0.1224*** [0.007]

0.0113*** [0.002] -0.0491*** [0.000] -0.0270*** [0.000] 0.2155* [0.068] -0.0755** [0.046]

0.0120*** [0.000] -0.0438*** [0.000] -0.0272*** [0.001] 0.1304 [0.204] -0.0471 [0.152]

0.0097*** [0.006] -0.0501*** [0.000] -0.0300*** [0.000] 0.2023* [0.082] -0.0697* [0.059] 0.1490** [0.040]

0.0109*** [0.002] -0.0455*** [0.000] -0.0297*** [0.001] 0.1285 [0.210] -0.0456 [0.162] 0.1041 [0.218]

-0.1264*** [0.000] 0.0602*** [0.007] 0.2628*** [0.000] -0.0761*** [0.000] -0.3526*** [0.000]

-0.1191*** [0.000] 0.0585*** [0.007] 0.2423*** [0.000] -0.0685*** [0.001] -0.3361*** [0.000]

0.1996*** [0.000] 2,300

-0.1098*** [0.001] 0.0475** [0.021] 0.1272** [0.046] -0.0353* [0.081] -0.1944* [0.064] -0.0076 [0.295] 1.2720*** [0.000] 0.1890*** [0.000] 2,020

0.139 46

0.154 44

Leverage Residual

∆RER(-1) ∆M2(-4)

Observations

0.2460*** [0.000] 2,576

0.1856*** [0.000] 2,576

0.2004*** [0.000] 2,300

-0.1156*** [0.000] 0.0485** [0.021] 0.1313** [0.042] -0.0370* [0.064] -0.1964* [0.067] -0.0120* [0.091] 1.2705*** [0.000] 0.1995*** [0.000] 2,020

R # Countries

0.071 46

0.076 46

0.137 46

0.153 44

GDP growth(-4) DEBT/GDP(-4) Inflation(-4) Stock Volatility(-4) Bank ROA(-4) Constant

2

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

49

Individual Country Effects Separate panel regressions for each country: ∆Lc,t = β c,0 + β c,1VIXt−1 + β c,2VIXt−1 ∗ Countryc +β c,3∆Interofficet + controlsc,t + ec,t

∆Lc,t = β c,0 + β c,1∆Interofficet + β c,2∆Interofficet ∗ Countryc +β c,3VIXt−1 + controlsc,t + ec,t

Sum β c,1 + β c,2 measures the total effect on country c. incremental country-specific effect.

β c,2 measures

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

∆Interoffice ∆Interoffice*Korea ∆Interoffice*Korea*Post 2010 VIX

50

1

2

3

4

5

6

0.0104*** [0.000]

0.0076*** [0.002]

0.0074*** [0.003] 0.0107*** [0.000]

0.0075*** [0.002]

0.0076*** [0.002]

-0.0629*** [0.000]

-0.0498*** [0.000]

-0.0498*** [0.000]

0.0074*** [0.003] 0.0195*** [0.000] -0.0314*** [0.000] -0.0499*** [0.000]

-0.0485*** [0.000] -0.0621*** [0.000]

-0.0214*** [0.001] -0.0481*** [0.000]

-0.0211*** [0.001] -0.0549*** [0.000] 0.7617*** [0.000] 0.3008*** [0.000] -0.0806** [0.015] 0.2729*** [0.000] 2,892 0.146 48

-0.0212*** [0.001] -0.0547*** [0.000] 0.7618*** [0.000] 0.3002*** [0.000] -0.0805** [0.015] 0.2728*** [0.000] 2,892 0.146 48

-0.0211*** [0.001] -0.0547*** [0.000] 0.7620*** [0.000] 0.3001*** [0.000] -0.0806** [0.015] 0.2731*** [0.000] 2,892 0.146 48

-0.0485*** [0.000] -0.0631*** [0.000] 0.0026* [0.071] -0.0212*** [0.001] -0.0539*** [0.000] 0.7627*** [0.000] 0.3012*** [0.000] -0.0814** [0.014] 0.2720*** [0.000] 2,892 0.147 48

VIX *Korea VIX *Korea*Post 2010

∆VIX RER

∆Money stock GDP Growth Debt to GDP Constant Observations R-squared Number of countries

0.2962*** [0.000] 3,120 0.057 48

-0.0212*** [0.001] -0.0539*** [0.000] 0.7628*** [0.000] 0.3013*** [0.000] -0.0813** [0.014] 0.2720*** [0.000] 2,892 0.147 48

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

β c,2

VIX*Estonia

β c,2

VIX*Latvia

β c,2

VIX*Turkey

β c,2

VIX*Brazil

β c,2

β c,1+β c,2≥ 0

51

Reject

∆Interoffice*Estonia

Reject

∆Interoffice*Latvia

Reject

∆Interoffice*Turkey

-0.0033 [0.511]

Reject

∆Interoffice*Brazil

VIX*Chile

Do not Reject

∆Interoffice*Chile

β c,2

0.0811*** [0.000]

VIX*Spain

Do not Reject

∆Interoffice*Spain

β c,2

VIX*UK

β c,2

VIX*Germany

β c,2

0.0378*** [0.000] 0.0051 [0.395] 0.0162*** [0.002]

VIX*Japan

0.0706*** [0.000]

Do not Reject

-0.0033 [0.690] -0.0235** [0.027] -0.0052 [0.533]

Reject

∆Interoffice*UK

Reject

∆Interoffice*Germany ∆Interoffice*Japan

0.0189*** [0.000] 0.0063** [0.017] -0.0031 [0.350]

β c,1+β c,2≤ 0 Reject

Reject Reject

-0.0064** [0.014]

Reject

-0.0121*** [0.000]

Do not Reject

0.0147*** [0.000] -0.0156*** [0.000] -0.0021 [0.384]

Reject

-0.0327*** [0.000]

Do not Reject Reject Do not Reject

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

52

Table 2. Testing for endogeneity. Arellano and Bond (1991) dynamic system GMM. The tests indicate that the residuals in first differences (AR(1)) are correlated, but there is no serial correlation in second differences (AR(2)).

∆Interoffice(-1) BD Leverage(-1)

1

2

0.0306*** [0.000] 0.6244*** [0.000]

0.0297*** [0.000]

VIX(-1)

∆BD Leverage

-0.0519*** [0.001] 0.0064 [0.901]

∆VIX ∆Equity ∆L(-1) Constant Country controls Observations # countries AR(1) p-value AR(2) p-value Hansen test p-value

0.0025 [0.888] 0.0525** [0.044]

0.0632*** [0.009]

0.2134 [0.323] -0.1297*** [0.005] Y 2,300 46 0.004 0.25 0.132

-0.068 [0.709] 0.2435*** [0.001] Y 2,300 46 0.015 0.74 0.239

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

53

Table 3. Accounting for global factors. This table compares the adjusted R-squared statistics obtained from OLS regressions with time dummies, global variables (∆Interoffice, Leverage, ∆Leverage and ∆Equity), and local variables (GDP growth, Debt/GDP, Inflation, and ∆M2). Panel A is for the full sample of countries. Panels B is for the sample with large foreign bank presence and Panel C is for low foreign bank presence. 1

2

3

4

Y 0.0852 2,300

Y Y 0.154 2,300

5

Panel A: All sample Time dummies Global variables Local variables Adjusted R-squared Observations Panel B: High foreign bank presence Time dummies Global variables Local variables Adjusted R-squared Observations Panel C: Low foreign bank presence Time dummies Global variables Local variables Adjusted R-squared Observations

Y

Y Y

0.221 2,300

0.115 2,300

Y

Y Y

0.3 952

0.165 952

Y 0.136 952

Y Y 0.205 952

Y

Y 0.36 952 Y

Y 0.193 1,348

Y 0.269 2,300

0.101 1,348

Y 0.0554 1,348

Y Y 0.136 1,348

Y 0.231 1,348

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

Robustness Analysis • Crisis period dummy — Effect is larger during crisis period — But also at work during non-crisis periods • Developing country dummy — No difference between developing and developed economies — Europe effect?

54

Bruno and Shin: Capital Flows, Cross-Border Banking and Global Liquidity

55

Two Themes • Global financial conditions closely intertwined with cross-border banking • Global factors drive capital flows into diverse destination countries