Abstract
This paper forms the United Kingdom’s contribution to the International Banking Research Network’s project examining the impact of liquidity shocks on banks’ lending behavior, using proprietary bank-level data available to central banks. Specifically, we examine the impact of changes in funding conditions on U.K.-resident banks’ domestic and external lending from 2006 to 2012. The results suggest that, following a rise in the funding shock measure, U.K.-resident banks that grew their balance sheets quicker relative to their peers precrisis decreased their external lending by more relative to other banks, and increased their domestic lending. When the paper accounts for country of ownership, it finds that the same pattern was true for both U.K.-owned and foreign-owned banks, but more pronounced for U.K.-owned banks’ domestic and foreign-owned banks’ external lending. These results are robust to splitting the data into real and financial sector lending, the use of more granular bilateral country loan data and controlling for government interventions.
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Notes
Davies and others (2010) give a longer-run perspective of how the U.K. banking system evolved into a structure “with large balance sheets, significant functional and geographical diversity and complexity, a high level of leverage, and extensive network interconnectivity.”
A trigger ratio is the technical term for capital requirement, since regulatory intervention would be triggered if the bank capital to risk-weighted asset ratio fell below this minimum threshold.
Taking account of the following: (i) exclusion of banks with limited foreign funding activity; (ii) breaks in time series associated with the changes in reporting standards; (iii) loan securitizations; (iv) mergers and acquisitions; and (v) exchange rate movements. All of the variables (except “log real assets”) are winsorized at the 1st and 99th percentiles, to reduce the effect of outliers.
Information on internal market flows is only available at aggregate level.
The change in foreign loans refers to cross-border claims of U.K.-resident banks, Bank of England Form CC (App 1).
Holdings of cash and gilts. A liquid assets variable was used because the data for U.K.-resident banks’ assets is not sufficiently granular to be able to construct an “illiquid assets” variable analogous to that used in other contributions.
We loosely interpret this variable as “size.” Clearly, other bank attributes could be important in explaining bank behavior during this period, such as the risk-taking behavior of banks. Although we cannot measure risk taking precisely, to the extent that too-big-to-fail subsidies are responsible for such risk-taking behavior, this will be picked up in this “log real assets” variable.
Given the openness of the U.K. financial system, the LIBOR-OIS spread in the United Kingdom and United States moved in similar ways during the period under review, with a contemporaneous correlation of 0.92 (for example, see Chart 2 of Hoggarth, Hooley, and Korniyenko, 2013); we have therefore chosen not to re-run our regressions with the U.S. LIBOR-OIS spread.
These are split into three categories: (1) nationalization (where the stake of the government approaches 50 percent of equity); (2) public capital injections (where the injection relative to existing capital was small); and (3) liquidity insurance schemes.
The specification here is similar to that used in Aiyar and others (2014a).
Other contributions have focused their results for on domestically owned banks as their headline conclusions. We have chosen to focus on the full sample, given the importance of foreign-owned banks for the United Kingdom, as discussed above.
Recall that, due to the inclusion of bank and time fixed effects in our baseline regression, this has a specific meaning: the deviation of a bank’s total assets in levels from its own time-series average, relative to other banks. Therefore, the “largest” banks are not necessarily those with the highest level of assets, but those whose assets grew the most rapidly precrisis.
This figure is obtained as follows. In Table 2, Panel A, column 2, the coefficient for the interaction term of the LIBOR-OIS spread and log real assets is −0.367, significantly different from zero at 10 percent confidence. The funding shock in this case is assumed to be 1 percentage point. This gives us 1 × 1 × (−0.367)=−0.367 (that is, 36.7 percent). This is the figure by which total lending as a share of a bank’s balance sheet contracts relative to the average bank.
As foreign branches are not required to hold capital in their U.K.-resident entity, and they are a significant fraction of the foreign bank group, the capital ratio has been excluded from all foreign bank regressions.
References
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Additional information
*Robert Hills is senior manager of the European Economics team at the Bank of England. John Hooley is an economist in the IMF’s African Department, on secondment from the Bank of England. Yevgeniya Korniyenko is an economist in the IMF’s Strategy, Policy and Review Department, and was previously an economist at the Bank of England. Tomasz Wieladek is programme manager, responsible for research on the interaction of monetary and macroprudential policy, in the research hub at the Bank of England. The authors are grateful to Claudia Buch, Martin Brooke, Charles Calomiris, Linda Goldberg, Matthew Willison, and participants at the International Banking Research Network workshop in Potsdam for comments on a prior draft, and to Mark Robson and the other staff of the Bank of England’s Statistics and Regulatory Data Division for making the data on U.K. banks available to them and for helping them to access the data.
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Hills, R., Hooley, J., Korniyenko, Y. et al. International Banking and Liquidity Risk Transmission: Evidence from the United Kingdom. IMF Econ Rev 63, 606–625 (2015). https://doi.org/10.1057/imfer.2015.27
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DOI: https://doi.org/10.1057/imfer.2015.27