Financial Protectionism??

Andrew K Rose  of UC Berkeley and Tomasz Wieladek of BoE have this nice paper on the topic. It is perhaps the first paper on the topic (the authors also say so).

In the paper authors point to this interesting idea call protectionism measures by banks. When a bank gets nationalised does it lower its lending to international players? Does it charge higher interest rates?

The “Great Recession” which engulfed the world in 2008-09 is frequently compared  to the Great Depression of the early 1930s.  Many economists blame trade protectionism for  deepening, spreading, and/or lengthening the Great Depression.  This time around, there is  only muted evidence of traditional trade protectionism, at least thus far. But the public  sector has made substantial interventions in financial markets around the world, particularly  in the banking sector, while cross-border bank lending has fallen. In this study we ask if  government support for banks has reduced foreign lending to the UK and resulted in a new  type of protectionism: financial protectionism. 

The Bank of England May 2009 Inflation Report documents that in the years before  the global financial crisis, foreign lenders contributed substantially to the growth of lending  to UK residents. Following the global financial crisis this type of foreign  lending to the UK  economy has fallen drastically. If this decline is temporary, due to, for example, increased  risks in the UK economy as a result of the recession, foreign lenders will probably re-enter  the UK market once the recovery is entrenched. On the other hand, if this phenomenon is  longer lasting, possibly due to financial protectionism, the lack of access to foreign capital means that UK households and firms will need to roll over maturing loans over with  alternative sources of funding. Whether or not the decline in foreign lending is a result of  financial protectionism has therefore important implications for UK financial and monetary  policy.

They find international banks in UK seem to be engaging in fin protectionism:

We think of financial protectionism as a nationalistic change in banks’ lending  behaviour, as the result of public intervention, which leads domestic banks either to lend  less or at higher interest rates to foreigners. In this study, we take advantage of a panel data  set on bank activity collected by the Bank of England.  This data set covers all banks, both  foreign and domestic, which operating in the UK.  Our data spans 1997Q3 through 2010Q1,  a period characterized by the most significant international financial crisis in decades,  during which a number of British and foreign banks were nationalised or supported with not need to rely on explicit state support for their survival.  As such, this heterogeneity means that our data set is ideally suited to testing for financial protectionism.  

Our main focus is the fraction of domestic (British) loans a bank makes as a fraction  of its total loan activity, a ratio we refer to as the “loan mix,” though we also investigate interest rates.  Our key finding is that after nationalisation, foreign banks reduced British as a share of total lending by about eleven percentage points, and increased interest rates on new loans to UK residents by 70 basis points.  By way of comparison, nationalisation does not seem to affect either the lending or interest rate decisions of British banks.  These results are robust to a variety of perturbations to the underlying empirical model.  Succinctly, foreign nationalised banks seem to have engaged in financial protectionism, which British nationalised banks have not capital injections and/or loan guarantees.

Hmmm…Very interesting…

The authors add:

Our main message from this study is that the behaviour of foreign banks operating in  the UK seems to be consistent with financial protectionism.  Both the microeconomic causes  of this behaviour and its macroeconomic consequences (if any) remain unknown. We leave  those important issues for future research

All this actually undermines the efficiency of the international finance centre like UK. If foreign banks start lowering credit and hiking interest rates to UK customers themselves, why should they host them? On knowing these results, would UK banks start their own protectionism as well? What about other financial centres? Would they follow?

Actually unlike trade protectionism which is widely discussed, financial version  is just new. Will be interesting to see what follows…


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