Financial Contagion and Foreign Banks: Does the Vienna Initiative Need A Reevaluation? Evidence from the Transition Region

This study explores the impact of financial contagion on lending to the broader economy in the Transition region, specifically through the internal capital markets of global banks. Utilizing financial data from 100 Western European and Transition region parent banks and 212 subsidiaries, we find that after joint negative tail events in financial markets, foreign-owned banks in the Transition region reduce their lending to the real economy by more than domestic banks. Focusing on the Vienna Initiative of 2009, we find that banks that subsequently signed commitments to stop the payouts to their foreign parents reduced their lending growth the most. However, we do not find any evidence that these banks changed their lending behavior by increasing lending after signing the commitments. Therefore, even if the Vienna Initiative may have been effective in combating capital outflow, it could not induce an increase of lending to the real economy – one of its main goals. Overall, this study provides valuable insights for policymakers in effectively managing financial contagion and crisis transmission in the Transition region.