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Bank Lending, Bank Capital Regulation and Efficiency of Corporate Foreign Investment

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Author Info
Diemo Dietrich
Achim Hauck

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Abstract

In this paper we study interdependencies between corporate foreign investment and the capital structure of banks. By committing to invest predominantly at home, firms can reduce the credit default risk of their lending banks. Therefore, banks can refinance loans to a larger extent through deposits thereby reducing firms’ effective financing costs. Firms thus have an incentive to allocate resources inefficiently as they then save on financing costs. We argue that imposing minimum capital adequacy for banks can eliminate this incentive by putting a lower bound on financing costs. However, the Basel II framework is shown to miss this potential.

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Paper provided by Halle Institute for Economic Research in its series IWH Discussion Papers with number 4-07.

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Date of creation: Mar 2007
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Handle: RePEc:iwh:dispap:4-07

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Related research
Keywords: financial contracting; multinational corporations; internal capital markets;

Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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  1. Bertrand Rime, 2005. "Will Basel II Lead to a Specialization of Unsophisticated Banks on High-Risk Borrowers?," International Finance, Blackwell Publishing, vol. 8(1), pages 29-55, 07. [Downloadable!] (restricted)
  2. Roman Inderst & Holger M. Müller, 2003. "Internal versus External Financing: An Optimal Contracting Approach," Journal of Finance, American Finance Association, vol. 58(3), pages 1033-1062, 06. [Downloadable!] (restricted)
  3. Franklin Allen & Elena Carletti & Robert Marquez, 2006. "Credit market competition and capital regulation," Finance and Economics Discussion Series 2006-11, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  4. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December. [Downloadable!] (restricted)
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  5. Brusco, Sandro & Panunzi, Fausto, 2005. "Reallocation of corporate resources and managerial incentives in internal capital markets," European Economic Review, Elsevier, vol. 49(3), pages 659-681, April. [Downloadable!] (restricted)
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  6. Michael Klein & Joe Peek & Eric Rosengren, 2000. "Troubled Banks, Impaired Foreign Direct Investment: The Role of Relative Access to Credit," NBER Working Papers 7845, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November. [Downloadable!] (restricted)
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  8. Repullo, Rafael & Suarez, Javier, 2004. "Loan pricing under Basel capital requirements," Journal of Financial Intermediation, Elsevier, vol. 13(4), pages 496-521, October. [Downloadable!] (restricted)
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  9. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
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  10. Rafael Repullo, 2002. "Capital requirements, market power, and risk-taking in banking," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 150-163.
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  11. David S. Scharfstein & Jeremy C. Stein, 2000. "The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(6), pages 2537-2564, December. [Downloadable!] (restricted)
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  12. Mihir A. Desai & C. Fritz Foley & James R. Hines, 2004. "A Multinational Perspective on Capital Structure Choice and Internal Capital Markets," Journal of Finance, American Finance Association, vol. 59(6), pages 2451-2487, December. [Downloadable!] (restricted)
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