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International Diversification Gains and Home Bias in Banking

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  • Alicia García-Herrero
  • Francisco F. Vázquez

Abstract

This paper assembles a bank-level dataset covering the operations of 38 international banks from eight industrial countries and their subsidiaries overseas during 1995-2004, and studies the extent of diversification gains from their local operations abroad. The paper finds that international banks with a larger share of assets allocated to foreign subsidiaries, particularly to those located in emerging market countries, are able to attain higher risk-adjusted returns. These gains are somewhat reduced- but by no means depleted-when international banks concentrate their subsidiaries in specific geographical regions. The paper also finds a substantial home bias in the international allocation of bank assets, relative to the results of a mean-variance portfolio optimization model. Overall, international diversification gains in banking appear to be substantial, albeit largely unexploited by current bank expansion strategies. These results suggest that international diversification gains could usefully be considered in the second pillar of Basel II as the first pillar is based only on the idiosyncratic risk of recipient countries.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/281.

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Length: 29
Date of creation: 01 Dec 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/281

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Keywords: International banking; Bonds; Emerging markets; international banks; subsidiaries; financial statements; money market; bond yields; government bond yields; money market rates; government bonds; government bond; bond; capital markets; financial globalization; money market rate; international contagion; capital flows; domestic securities; equity returns; securities portfolios; financial intermediation;

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References

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  1. Claudia M. Buch & John C. Driscoll & Charlotte Ostergaard, 2004. "Cross-Border Diversification in Bank Asset Portfolios," Working Paper, Norges Bank 2004/11, Norges Bank.
  2. Andrei Shleifer & Robert W. Vishny, 1998. "The Quality of Government," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1847, Harvard - Institute of Economic Research.
  3. Viral V. Acharya & Iftekhar Hasan & Anthony Saunders, 2002. "The effects of focus and diversification on bank risk and return: evidence from individual bank loan portfolios," Proceedings, Federal Reserve Bank of Chicago 905, Federal Reserve Bank of Chicago.
  4. Levy, Haim & Sarnat, Marshall, 1970. "International Diversification of Investment Portfolios," American Economic Review, American Economic Association, American Economic Association, vol. 60(4), pages 668-75, September.
  5. Evelyn Hayden & Daniel Porath & Natalja von Westernhagen, 2006. "Does Diversification Improve the Performance of German Banks? Evidence from Individual Bank Loan Portfolios," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 110, Oesterreichische Nationalbank (Austrian Central Bank).
  6. James R. Barth & Gerard Caprio, Jr. & Ross Levine, 2002. "Bank Regulation and Supervision: What Works Best?," NBER Working Papers 9323, National Bureau of Economic Research, Inc.
  7. von Westernhagen, Natalja & Porath, Daniel & Hayden, Evelyn, 2006. "Does diversification improve the performance of German banks? Evidence from individual bank loan portfolios," Discussion Paper Series 2: Banking and Financial Studies 2006,05, Deutsche Bundesbank, Research Centre.
  8. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  9. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, American Finance Association, vol. 7(1), pages 77-91, 03.
  10. Kenneth R. French & James M. Poterba, 1991. "Investor Diversification and International Equity Markets," NBER Working Papers 3609, National Bureau of Economic Research, Inc.
  11. Lessard, Donald R, 1973. "International Portfolio Diversification: A Multivariate Analysis for a Group of Latin American Countries," Journal of Finance, American Finance Association, American Finance Association, vol. 28(3), pages 619-33, June.
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Cited by:
  1. Cetorelli, Nicola & Goldberg, Linda S., 2008. "Banking globalization, monetary transmission and the lending channel," Discussion Paper Series 1: Economic Studies 2008,21, Deutsche Bundesbank, Research Centre.
  2. García-Herrero, Alicia & Gavilá, Sergio & Santabárbara, Daniel, 2009. "What explains the low profitability of Chinese banks?," Journal of Banking & Finance, Elsevier, Elsevier, vol. 33(11), pages 2080-2092, November.
  3. Lasse Steiner & Bruno S. Frey & Magnus Resch, 2013. "Home is where your art is: the home bias of art collectors," ECON - Working Papers, Department of Economics - University of Zurich 135, Department of Economics - University of Zurich.
  4. Bertay, Ata Can & Demirguc-Kunt, Asli & Huizinga, Harry, 2011. "Is the Financial Safety Net a Barrier to Cross-Border Banking?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8712, C.E.P.R. Discussion Papers.
  5. Markus Leibrecht & Johann Scharler, 2010. "Banks, Financial Markets and International Consumption Risk Sharing," Economics working papers, Department of Economics, Johannes Kepler University Linz, Austria 2010-15, Department of Economics, Johannes Kepler University Linz, Austria.
  6. Eric van Wincoop, 2011. "International Contagion Through Leveraged Financial Institutions," NBER Working Papers 17686, National Bureau of Economic Research, Inc.
  7. Georgiadis, Georgios, 2014. "Towards an explanation of cross-country asymmetries in monetary transmission," Journal of Macroeconomics, Elsevier, Elsevier, vol. 39(PA), pages 66-84.

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