Cross-border banking and the importance of parents banks' performance for subsidiaries' credit extensionsevidence derived from a newly constructed database

Resumen

The systemic role of foreign banks in the CESEE region coupled with the turbulence in financial markets back in 2008, have given rise to the study at hand. Some years after the global crisis, it is a perfect moment to conduct an overarching analysis of the parent-subsidiary relationship and to examine how those banks behave at micro level. Firstly, the study discerns between different types of foreign ownership and explores their propensity to extend credit vis-à-vis their domestic owned competitors. Secondly it focuses on banks, which are members of foreign financial groups and which constitute the vast majority of foreign owned banks with operations in the CESEE region. It investigates whether the parent level can explain any of the variation of subsidiaries' capability to extend credit. Thirdly it looks into the particular parent bank characteristics with an influence on subsidiaries credit growth. Fourthly it researches whether the ownership effect changes after the crisis. Finally, it investigates the effect of the business cycle on subsidiaries' credit extensions and how the business cycle of the home country of the parent bank matters. A prerequisite for this investigation is the understanding of the actual ownership structure and changes. Banking sectors in the region are rather dynamic and characterized by entries, exits and changes of ownership, while major corporate restructuring has taken place at the parent level too. Therefore the present study is grounded in a unique and new database, which complements the empirical literature in several ways. It has both a wide geographical and sectorial coverage, while it has adopted a more thorough definition of foreign ownership that captures the cross border relationships at full extent. It identifies the ultimate owner of each subsidiary bank, instead of focusing only on the direct ownership. The final sample spans over the period 2000-2014 and includes 323 banks (domestic and subsidiary banks) operating in 18 countries of Central Eastern and Central Eastern Europe (CEESE) and 84 ultimate owner banks (parents). The empirical exploration is divided into three logical steps. First, the study provides insights on the impact of foreign ownership on host countries’ credit growth. Credit growth is modeled in a dynamic framework employing GMM estimation methodologies and accounting for ownership, individual bank characteristics as well as macroeconomic effects. Second, it is investigated the homogeneity of loan growth across subsidiaries belonging to the same international financial group (parent), operating in different markets. In this step a Crossed Random Effects Model is employed. By doing so, it is proved that there is an omitted common effect across the subsidiaries. Therefore the empirical models employed above, can produce consistent estimates of the credit growth of subsidiaries only if controls are added for those factors. Which leads to the third step. In the dynamic credit growth model are added further parent bank variables/controls as well as parent related such as the country of origin of the parent and the macroeconomic conditions in the home country. Estimation results indicate that all types of foreign participation in the ownership structure are crucial to the performance of the subsidiary. However, members of foreign financial groups are bearing the largest influence and most significant one. Given that they constitute the largest category of foreign owners, it is crucial to investigate further their behavior. Subsidiaries' credit behavior cannot be viewed in isolation. To the contrary, it needs to be framed into the operating landscape, which includes the linkages to foreign entities and their economies. Subsidiaries' profitability has been found significant only rarely. Therefore, subsidiaries do not fund their growth through their own profits. This indicates a longer-term expansion strategy of parents in the region, whereby current profitability at the domestic level is a secondary parameter. Parents' asset quality (loan impairment charges) is a relevant determinant of credit growth at subsidiary level. Loan impairment charges are also at subsidiary level significant. Loan impairments are the result of the project screening intelligence at consolidated level. The global financial crisis determined losses for banks and a deterioration of their loan portfolio. The measure of loan impairments and their effect on credit growth capture intrinsic characteristics of parents such as their ability to manage their portfolios and choose to finance profitable projects. Finally, a peer group analysis unveils that risky behaviors at the parent bank level jeopardize future credit extensions at the subsidiary level. Specifically, excessive credit expansion and reduction of economic capital ratios lead to a decline in subsidiaries' lending capacity in three years’ time. Overall, the presence of foreign banks in the CESEE region is judged as beneficial. Parent banks originated from flourishing economies benefit the host countries, through further extensions of credit by their subsidiaries. Indeed, they have contributed to a contraction of credit after the global financial crisis. Yet, their reaction was less pronounced compared with the contraction exercised by domestic banks.