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Were Multinational Banks Taking Excessive Risks Before the Recent Financial Crisis?

Author

Listed:
  • Mohamed Azzim Gulamhussen

    () (University of Lisbon)

  • Carlos Pinheiro

    () (Caixa Geral de Depositos)

  • Alberto Franco Pozzolo

    () (Università degli Studi del Molise, MoFiR, CASMeF and Centro Studi Luca d\'Agliano)

Abstract

The recent financial crisis has clearly shown that the relationship between bank internationalization and risk is complex. Multinational banks can benefit from portfolio diversification, reducing their overall riskiness, but this effect can be offset by incentives going in the opposite direction, leading them to take on excessive risks. Since both effects are grounded on solid theoretical arguments, the answer of what is the actual relationship between bank internationalization and risk is left to the empirical analysis. In this paper, we study such relationship in the period leading to the financial crisis of 2007-2008. For a sample of 384 listed banks from 56 countries, we calculate two measures of risk for the period from 2001 to 2007 – the expected default frequency (EDF), a market-based and forward-looking indicator, and the Z-score, a balance-sheet-based and backward-looking measure – and relate them to their degree of internationalization. We find robust evidence that international diversification increases bank risk.

Suggested Citation

  • Mohamed Azzim Gulamhussen & Carlos Pinheiro & Alberto Franco Pozzolo, 2012. "Were Multinational Banks Taking Excessive Risks Before the Recent Financial Crisis?," Development Working Papers 332, Centro Studi Luca d'Agliano, University of Milano, revised 16 Jul 2012.
  • Handle: RePEc:csl:devewp:332
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    References listed on IDEAS

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    More about this item

    Keywords

    Banks; Risks; Multinational Banking; Economic Integration; Market structure;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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