International lending during the credit crisis: attraction to the familiar

News
Date 9 February 2011

During the credit crisis, international lending in some countries took a much heavier blow than in others. In times of crisis especially, it’s convenient to have a bank around the corner. This emerged in recent research by Neeltje van Horen of De Nederlandsche Bank and Ralph de Haas of the European Bank for Reconstruction and Development (EBRD).

   
International lending took a hit during the credit crisis, much more so than banks’ domestic lending. Strikingly, banks reduced their cross-border lending in some countries much faster than in others. De Haas and Van Horen researched the reasons for such big differences across countries.

Information on customers

Lending generally falls off in economically bad times, because enterprises reduce investment and banks become more cautious in granting credit in view of the higher likelihood of failures and defaults. When the economy is weak, banks seek more certainty about the creditworthiness of their potential customers. They need sound and reliable information but that is not always easy to find. Different factors may either help or hinder: how distant a bank is from its customers, whether it has a subsidiary in the country of the potential customer, whether it has the opportunity to cooperate with local banks, and finally, whether it has the experience – because by doing regular business in a certain country, a bank learns the most effective way to obtain information. This study assessed the importance of each of these factors.

Lending in sixty countries

The researchers examined cross-border lending by 118 internationally operating banks, focusing on the market for syndicated loans, i.e. loans issued by a consortium of banks. For each of these banks, and for each country in which they operate, they calculated the degree to which international lending changed in the year after the collapse of Lehman Brothers relative to the period before the credit crisis. Subsequently, they tested which factors explain why banks reduced their lending more quickly in one country than in another.

Of the 118 banks examined, the majority had headquarters in Western countries such as the US, the UK and the Netherlands: the other banks were established in emerging economies including China, India and South Africa. Lending by these 118 banks is spread out over sixty countries worldwide.

Alarm bells

The further away, the vaguer, and the lower the credit: that seems to be the motto in times of a crisis, according to the research paper. The closer a bank’s headquarters is to its foreign customers, the more it cooperates in a network of local banks, and the more experience it has in the country of the potential client, the slower the decline in its cross-border lending. The further away a bank is from the country of the (potential) borrower, the less experience the bank has in that country and the less its involvement in cooperative arrangements with other local banks, the sooner the alarm bells will ring. In those situations, an international bank will have more difficulty in obtaining adequate information on a customer's creditworthiness and that puts lending under pressure. This not only applies to new customers, but also to customers with whom the bank has already dealt frequently.  

Interbank-loans form a striking exception: the amount that banks are prepared to lend to other banks during a crisis is totally unrelated to factors such as distance, the maintenance of a local subsidiary, local network, and/or experience. At the lowest point of the credit crisis, the mutual mistrust among banks was so deep that even a loan to a bank in a neighbouring country appeared too risky.  
      

Subsidiaries

For potential borrowers in emerging economies, the presence of an international bank’s subsidiary makes a big difference: it limits the reduction in cross-border lending during a crisis. International banks with a subsidiary in a certain country can obtain more information through their own people on the ground and this benefits their lending. In emerging economies it is often difficult to gather ‘hard’ information, such as credible statistical data. In that case, 'soft' locally obtained information on, say, the management qualities of a local entrepreneur could have added value. Emerging economies seeking to secure stable international loans during a crisis are hence well-advised to open their borders to subsidiaries of international financial concerns.

Running for the Exit

Van Horen and De Haas report on the results of their research in DNB Working Paper no. 279: Running for the Exit: international Banks and Crisis Transmission’.