Globalisation is a good thing, right? That’s the underlying message of most economics textbooks – indeed the centuries-old theory of comparative advantage has it that because international markets allow countries to specialise in what they are expert in, in turn all countries around the world can grow faster.
However, there is evidence that, when it comes to finance, globalised markets can make the booms bigger and the busts even more painful. Why? Well there are a variety of reasons, but one, illustrated quite vividly in a new piece of Bank of England research, is that when a crisis arrives, foreign banks often withdraw their lending from their overseas branches. Moreover (and I hadn’t really appreciated this until I saw the chart above) in the recent crisis, foreign bank branches in the UK (which account for about a third of banking system assets) also increased their lending significantly ahead of the bust.
As the Bank’s working paper says: “the typical foreign branch exhibited high procyclicality in its lending to the UK private sector during the crisis. The median branch had higher growth in domestic lending pre-crisis — to nearly all sectors — and a sharper contraction in growth during the crisis than both foreign subsidiaries and UK-owned banks.”
In short, foreign branches seem to have been more attracted to the volatile sectors which suffered the most during the crisis, and were then quicker to reallocate their money back to their home nation.
There are a few lessons – one is that this reinforces the suspicion that it is far easier for bank employees to make injudicious investment decisions in a country somewhere far away from the bank’s headquarters (consider the German banks who invested so much in sub-prime). Another (and this is the rejoinder to the globalisation-is-good maxim) is that foreign lending can be very capricious when there are global financial crises. This is partly because it is easier to cut jobs (and lending) overseas; it is partly because of various regulatory constraints that are slapped down during financial crises which encourage banks to relocate their capital back home.
It may also be a sign that some foreign banks (I’m thinking, quite feasibly those from the eurozone) had significantly weaker capital positions at the start of the crisis, and so were simply in a more vulnerable state when things started to deteriorate.
Either way, it helps explain why economies which were highly-reliant on finance for economic growth have suffered so much in the past five years.