Multinational banking in Europe – financial stability and regulatory implications: lessons from the financial crisis[Cross subsidies, external financing constraints, and the contribution of the internal capital market to firm value]

This paper examines whether multinational banks have a stabilizing or a destabilizing role during times of financial distress. With a focus on Europe, it looks at how these banks’ foreign affiliates have been faring during the recent financial crisis. It finds that retail and corporate lending of these foreign affiliates has been stable and even increasing between 2007 and 2009. This pattern is related to the functioning of the internal capital market through which these banks funnel funds across their units. The internal capital market has been an effective tool to support foreign affiliates in distress and to isolate their lending from the local availability of financial resources, notwithstanding the systemic nature of the recent crisis. This effect has been particularly large within the EU integrated financial market and for the EMU countries, thus showing complementarity between economic integration and multinational banks’ internal capital markets. In light of these findings, this paper supports the call for an integration of the European supervisory and regulatory framework overseeing multinational banks. The analysis is based on an analytical framework which derives the main conditions under which the internal capital market can perform this support function under idiosyncratic and systemic stresses. The empirical evidence uses both aggregate evidence on foreign claims worldwide, and firm-level evidence on the behaviour of banking groups’ affiliates, compared to stand-alone national banks.— Giorgio Barba Navaretti, Giacomo Calzolari, Alberto Franco Pozzolo and Micol Levi