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Chapter 3

Lessons of crisis transmission

How did the experience of the 2008-09 global financial crisis change this picture? For the most part, it confirmed previous findings on international crisis transmission. Multinational banks transmitted the crisis to emerging markets, including eastern Europe, through a reduction in cross-border lending and local subsidiary lending. Although domestically owned banks – many of which had borrowed heavily on the international syndicated loan and bond markets before the crisis – were also forced to contract credit, foreign bank subsidiaries in emerging Europe generally reduced lending earlier and faster.17 The experience of 2008-09 also confirms that the structure of international financial linkages matters. For example, crisis transmission to Latin America was less severe in countries where foreign banks were lending through subsidiaries rather than across borders.18 As in previous crises, cross-border lending turned out to be a relatively volatile funding source, with international banks refocusing on domestic clients while retrenching especially from distant countries and countries where they had less lending experience.19 That said, the 2008-09 experience was instructive in three respects particularly.

  • Some of the generally positive impact of foreign banks on local financial systems prior to 2008 – in particular, allowing more firms and households to access credit – was revealed to be part of an unsustainable, and in many cases harmful, credit boom. Similarly, some products introduced by foreign banks – most notoriously, mortgage loans denominated in Swiss francs in Hungary – were now seen as risky practices rather than beneficial financial innovation. At one level, these experiences merely underline the well-known fact that the presence of foreign banks can exacerbate credit booms, but they also drove home the point that destructive credit booms and beneficial financial deepening can be difficult to distinguish, giving regulators and supervisors a critical role. As shown below, these roles can be particularly difficult to exercise in the host countries of large foreign banks.
  • The crisis underlined just how extensive crisis transmission by foreign banks can be if their affiliates are of local systemic importance. This has been especially evident in some of the emerging European countries where one or more of the top three banks are in foreign hands. It was this combination of foreign ownership and local systemic importance that threatened financial stability in several of these countries – particularly those which had previously experienced large, foreign-currency denominated credit booms – and necessitated the ad hoc establishment of the European Bank Coordination ("Vienna") Initiative (see also page 53 below).20
  • Funding structure turned out to be very important for banking stability. Excessive wholesale borrowing exposed banks to bouts of illiquidity in short-term funding and interbank foreign exchange (FX) swap markets. This lesson is relevant both for foreign and domestic banks. While foreign banks had easy access to parent bank and wholesale funding, many domestic banks were increasingly able to access international wholesale and FX swap markets as well. When the crisis struck, it was these domestic banks that proved the weakest link. They almost immediately lost access to cross-border borrowing or could no longer swap such funding into the desired currencies, such as Swiss francs, and had no recourse to a supportive group structure. At the same time, the Latin American experience showed that a large-scale foreign bank presence may go hand in hand with financial stability if sufficient local deposit and wholesale funding is available.21

The significance of the 2008-09 crisis, therefore, was not so much to offer fundamentally new insights into the risks of foreign bank presence – these were already understood by then – but rather in teaching a lesson on just how much damage these risks could cause in unprepared countries. At the same time, the crisis experience suggested some ways to reduce these risks while still reaping the benefits of financial integration. First, there is a prima facie diversification argument against foreign bank control of a large majority of banking assets – at least when these banks are heavily dependent on external funding. Second, there seems to be a general stability argument for local funding, whether on the side of foreign or domestic banks. To make local funding a realistic option – particularly longer-term funding – some emerging European countries need to enhance the credibility of their macroeconomic frameworks in terms of inflation targeting and more flexible exchange rate regimes.22 Such action has helped Latin America to de-dollarise and subsequently create a more stable form of financial integration. Lastly, the painful bursting of pre-crisis credit bubbles suggests a need to pay much greater attention to preventing them in the first place. As the next section explains, this can be difficult in an environment of cross-border and multinational banking as long as supervision remains only nationally based.

17 See Claessens and Van Horen (2012) and De Haas and Van Lelyveld (2011).

18 See Kamil and Rai (2010).

19 See De Haas and Van Horen (2012) and Giannetti and Laeven (2012).

20 As part of the Vienna Initiative a number of western European banks signed country-specific commitment letters in which they pledged to maintain exposures and to support their subsidiaries in central and eastern Europe. De Haas et al. (2012) and Cetorelli and Goldberg (2011) provide empirical evidence on the stabilising impact of the Vienna Initiative.

21 Ongena et al. (2012) and Kamil and Rai (2010).

22 See EBRD (2010), Chapter 3.


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