Whither international banking?

Strong regional and global integration have been central to countries’ rapid growth and reduced poverty. Few economic sectors can better illustrate integration’s potential benefits — and its significant risks — than the banking sector.

The period prior to the 2008 global financial crisis was characterized by a significant increase in financial globalization, which coincided with dramatic increases in bank sizes. This was manifested both in a rise in cross-border lending and in the growing participation of foreign banks around the world, especially in developing countries. These trends resulted in: additional capital and liquidity; efficiency improvements through technological advancements and competition; and, eventually, greater financial development.

However, when the crisis hit, it also vividly demonstrated how international banks can transmit shocks across the globe. It became clear that systems in place to manage the risks associated with financial globalization were seriously flawed. The results were devastating to economies and to people, halting progress in the fight against poverty, affecting their incomes, health, and prospects for years to come.

Not surprisingly, the crisis resulted in a reevaluation of global banking, with some observers noting that it was partly responsible for its viral transmission across borders. There were indications that risk calculations were often confined to slices of financial activity, frequently overlooking systemic risk, and focusing on specific instruments. There were also concerns about global systemically important banks which were deemed too big and too connected to fail.

As the world economy slowly recovered, a backlash against globalization led many developing countries to clamp down on the activities of international banks. Yet, according to the new World Bank Global Financial Development Report (GFDR) 2017/2018: Bankers without Borders, policymakers should carefully consider their stance toward international banks, as these institutions can inject the capital, expertise, and technologies needed for broad-based and equitable growth that reduces poverty.

The report outlines policy measures developing countries can take to reap the benefits of international banking, including vigorously enforcing property and contractual rights, guaranteeing strong supervision of banks, and upgrading their credit registries to enhance information sharing. This work is essential if countries are to fully recover from the crisis, and if they aspire to reach the very ambitious Sustainable Development Goals, which seek to help all nations protect people and the planet, while leaving no one behind.

This GFDR, the fourth in a series, contributes to the financial sector policy debates regarding international banking. It builds on novel data, surveys, research, and wide-ranging country experience, with an emphasis on emerging markets and developing economies.

Three critically important areas of focus in international banking were emphasized, representing new trends, opportunities, and challenges for market participants, policymakers, and regulators:

  • First, South-South banking is on the rise and international banking is more regionalized. Globally, bank lending is pro-cyclical, increasing during booms and falling during downturns. But in developing countries, the lending pattern of international banks is significantly less procyclical compared to domestic counterparts. However, regionalization in the South limits risk-sharing and implies a larger exposure of an economy to shocks within the region. South-South banks may also bring increased risks stemming from more lax regulation in their home countries and could amplify credit booms in host countries.
  • Second, there is a shift towards alternative sources of funding. Large firms in developing countries increased their use of capital markets in the wake of the crisis. In developing countries, these firms also switched toward domestic banks and away from international banks. While alternatives need to be recognized, the important role of banks remains for the majority of firms in developing countries.
  • Finally, there is an influence of technology — fintech — on international banking. It’s likely to reshape competition in global finance as it will increase the speed and reduce the cost of global payments and transfers, financial inclusion, and cross-border banking. Technology can remove the need for a third party to clear and settle payments. Risks include the misuse of personal data, difficulties identifying customers, electronic fraud, facilitating illicit transactions, the need for consumer protection, and the lack of safety nets.  The key challenge here will be to regulate and monitor the development of the industry without over-regulation.

Countries that remain open can continue to benefit from global flows of funds, knowledge, and opportunity — but the regulatory space is complex and, at times, daunting to navigate. Encouraging the right type of foreign bank presence or forms of capital flows — without causing distortions — is challenging but critical. Efforts to address these areas of work need to involve extensive cross-border coordination with regulatory bodies and international financial institutions, and through south-south exchanges.

This report can help contribute answers to some of the most vital questions regarding international banking (e.g., addressing growth, poverty, shared prosperity, the stability of the financial system), with an aim to inform the debate that is taking place among policymakers — and to provide tailored solutions to some of the more critical development challenges.