At the joint conference “International Banking Networks: Sources of Stability or Instability? Evidence from the Past and Present” of the House of Finance (HoF) at Goethe University Frankfurt, the Leibniz Institute for Financial Research SAFE, and the Institute for Banking and Financial History (IBF) central bankers, economists, and economic historians presented the latest research findings on the functioning of international banking networks and on possible instruments to counter any inherent stability and financial risks. Catherine Schenk, this year's HoF visiting professor for “Financial History”, had invited to the event on 22 April 2021. The academic contributions to the conference made it clear that macroprudential policies and regulations need to address all facets of international banking relationships, which requires empirically based analyses of the functions and mechanisms of international banking networks.
Two keynotes from the current central bank perspective framed the two sections, each highlighting a historical and a contemporary aspect of the topic. The first was given by Linda Goldberg, Vice President of the Federal Reserve Bank of New York, who discussed the measurement of swap agreements as liquidity aids by central banks to maintain international payment flows, as well as outlining lessons learned during the global financial crisis and the handling of the instruments in the crisis triggered by the Corona pandemic. Correspondingly, Goldberg elaborated on factors affecting the role of international banks in the current crisis, such as the relaxation of macroprudential rules, the capitalization of financial intermediaries, and the different pace of the fight against Covid-19 in different countries. Well-capitalized, internationally positioned banks could expand abroad in this situation and contribute to economic stabilization in markets still affected by the Covid-19 crisis.
The following section on historical aspects of international banking networks was chaired by Catherine Schenk and featured presentations by Wilfried Kisling (Vienna University of Economics and Oxford University), Olivier Accominotti (London School of Economics), Mark Carlson (Board of Governors of the Federal Reserve System) and Natacha Postel-Vinay (London School of Economics), focusing on two time periods: the period of the first globalization and the interwar period. The speakers highlighted different institutional structures as well as the effects of international banking networks and explored the question of what destabilizing effects cross-border financial flows of banks can trigger.
International financial crises in the 1920s and 1930s
Wilfried Kisling, in a paper with Christopher Meissner (University of California, Davis) and Chenzi Xu (Stanford Graduate Business School), concluded based on data on bilateral linkages between bank branches and trade in the late 19th century that foreign trade development was spurred by the international expansion of banks. Olivier Accominotti (London School of Economics) documented the market structures behind the handling of this financial instrument through his comprehensive analysis, conducted with Delio Lucena-Piquero and Stefano Ugolini (both from the University of Toulouse), of sterling bills submitted to the Bank of England for rediscount in 1906. According to the authors, the network of internationally active London banks involved as discount houses overcame information asymmetries and thus made the bill of exchange a highly liquid financial instrument.
The spill-over effect of international financial crises was addressed by Mark Carlson (Board of Governors of the Federal Reserve System), whose analysis of the U.S. money and bond market in the early 1930s showed that capital outflows triggered by international developments – such as the German banking crisis of 1931 or the devaluation of sterling – were not without consequences for the domestic capital market, meaning that the rising uncertainty was not exclusively due to domestic misdevelopments. According to recent research by Natacha Postel-Vinay (London School of Economics) and Stephanie Collet (Deutsche Bundesbank), the inflow of international capital in favor of domestic banks can also have a destabilizing effect on the domestic banking market. The presentation also addressed the question of whether the substantial international capital inflows in favor of German banks in the 1920s had demonstrably led to greater risk-taking and excessive lending and could thus be regarded as one of the main causes of the banking crisis in the early 1930s.
Swap agreements are gaining in importance
The second section, chaired by Rainer Klump (Goethe University Frankfurt), focused on recent developments in both the institutional structure of the international banking network and instruments for managing the liquidity of international financial flows. The decline in correspondent banking relationships over the past decade, which has mainly affected countries with less sustainable supervisory structures, was the subject of the contribution by Goetz von Peter together with Tara Rice (both from the Bank for International Settlements). According to this paper, regulatory requirements for banks located in developed financial markets as well as cost reasons are among the possible causes. The development could result in the affected countries losing their connection to secure payment corridors altogether or liquid funds only being available at higher costs. This could be remedied by both new technologies and targeted countermeasures.
Beatrice Scheubel (European Central Bank) discussed the growing importance of central banks' swap agreements to contain crises caused by interrupted international payment flows, based on joint research with Hannah Engljähringer (Sant'Anna University Pisa) and Alice Schwenninger (Banque de France). Further in-depth analysis of the data would be needed to tailor the appropriate instruments to the respective requirements or crisis phenomena and to use them to counteract them, for example to absorb the effects of monetary policy.
Finally, Inaki Aldasoro (Bank for International Settlements) looked at the growing cross-border links between banks and shadow banks or rather non-bank financial intermediaries. These exist mainly for developed economies and offshore centers, but are increasingly relevant for emerging markets as well, and are associated with significant risk for banks in relation to shadow banks.
Financial stability risks in times of Corona
Commenting on the second section, Loriana Pelizzon, director of the research department Financial Markets at SAFE, asked about the role of technological change, particularly the emergence of digital payment providers, in the decline of correspondent banking links. On research on swap agreements, she suggested looking beyond their uses to the functional deficiencies of markets and exploring the causes of a drawdown in global financial safety nets. Pelizzon also asked about the causes of the fragility of cross-border linkages between banks and shadow banks seen with the Covid 19 pandemic. Overall, she said, it is important to explore the economic functions of shadow banks, including in comparison with those of banks, and the reasons for the strong growth of the international financial sector network.
Finally, the need to analyze the emerging successes of crisis-preventive financial market policies in the Covid 19 crisis based on comprehensive micro data was emphasized by Claudia Buch, Vice President of the Deutsche Bundesbank, in her keynote speech on financial stability risks in times of the Corona pandemic. The current challenges concern both liquidity and capital adequacy of banks and are also due to accelerated structural change. This is driven, among other things, by digitalization, the low interest rate environment, and the growing indebtedness of both the private and public sectors. Policymakers now have the right tools to deal with stability risks, but there are still gaps. In addition to the challenge posed by the crisis-induced increase in defaults, the growing complexity of banks needs to be addressed.
In her conclusion as conference chair, Catherine Schenk emphasized that the research questions raised in the conference centered around three sets of issues: The role of shadow banks in the international networks of banks and other financial institutions and the development of associated cross-border financial flows, the mechanisms and pathways of crisis transmission through the network of international financial institutions, and the ongoing transformation in the architecture of the international financial infrastructure.