Do you really want to lend more across borders?

by Richard P. Mattione

NichiLA Research Paper 9, prepared for the “Symposium on Building the Financial System of the 21st Century: An Agenda for Japan and the United States,” Odawara, Japan, October 2019.

2007

2019

What, Me Lend Across Borders?

Do you really want to lend more across borders? “Neither a borrower nor a lender be; for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry.” – William Shakespeare, Hamlet1 “Don’t lend money to friends; it causes amnesia.” -- Anonymous Cross-border bank lending has not recovered to the levels that prevailed just before the financial meltdown of 2007-09, and there is a presumption that it would be desirable to see more lending across borders. Yet it never hurts to step back and see why financial deepening has instead been replaced by financial balkanization, and what shapes and forms that balkanization has taken. Otherwise, the measures taken might encourage the wrong type of lending across borders, and thereby create the unwelcome opportunity to see a replay of 2007 to 2012 in the financial markets. The macroeconomic environment The stylized macroeconomic story of the years following the great recession of 2008-09 is fairly well known. First, the authorities provided lots of liquidity, especially in the United States where the assistance came in the form of TARP (Troubled Asset Relief Program). This carried the United States and the world through the immediate problems of financial meltdown. Europe moved much more slowly on this part of the program when its turn came in 2011-12. After some quick fiscal fixes, most of the industrialized world turned to a variety of quantitative easing (QE) policies, molded by the lessons learned from Japan’s multi-decade slowdown in growth after its stock and land market bubbles burst at the end of 1989. The monetary base exploded around the world (see Chart 1). The Federal Reserve slowed, then stopped, the U.S. monetary expansion (“tapering”), then moved on to hikes in short term interest rates (the ninth since December 2015 went into effect in December 2018, prompting Trumpian calls to fire the Fed).2 Until late 2018 the Fed had been discussing how to sell or roll off the holdings of Treasury and mortgage-backed securities, though more recently the discussion has moved toward whether enough shrinkage has already been accomplished.3 The United Kingdom started a tightening, but for the last three years has been stuck on Brexit. The market had glimpsed tapering from the European Central Bank (ECB). But in Europe, too, the more recent concern has been slow growth, and yields on 10-year bunds have dropped below zero. Fears were great enough that the ECB recently cut rates again and reinstated its program for buying government bonds.4 The market has already seen tapering in Japan (the expansion is the monetary base has definitely slowed), yet the yield on 10-year JGBs has moved below the lower band.5 Somehow the Swiss monetary base just goes up and up through it all (again, see Chart 1).

1 http://www.notable-quotes.com/l/lending_quotes.html 2 Peter Nicholas, Michael Wursthorn, and Paul Kiernan, “As market rout continues, president stands firm on Fed, border wall,” Wall Street Journal, December 25, 2018. 3 Spencer Jakab, “Powell now owns the Fed’s balance sheet problem,” Wall Street Journal, January 30, 2019. 4 Martin Arnold, “ECB launches fresh stimulus with rate cut and more bond buying,” Financial Times, September 12, 2019. 5 The official phrasing was that the rate on 10-year JGBs is pegged at 0, with policy responses to be triggered when rates moved move than 10 basis points either side of the zero target. From July 2018 that band seemed to have expanded to 20 basis points, when the BoJ tolerated a yield of 11 basis points on 10-year JGBs.

Australia never suffered a recession in the decade after the financial meltdown, and real GDP in Canada and Switzerland exceeded pre-crisis levels (in aggregate, not per capita, terms) before the end of 2010. The United States, France, and Germany had to wait until late 2011 for real GDP to exceed pre-crisis peaks; Japan and the United Kingdom until 2013 (see Chart 2). Progress has been glacial in much of the European periphery. Of the so-called PIIGS (Portugal, Ireland, Italy, Greece, and Spain), Ireland achieved real GDP above the pre-crisis peak in 2014; Spain in 2017; and Portugal in the second half of 2018.6 Labor markets also paint a mixed picture. Unemployment rates in Germany, the United States, the United Kingdom, and Japan are below pre-crisis levels; among the PIIGS, only in Ireland and Portugal have unemployment rates fallen back to pre-crisis levels (see chart 3). Through 2018 trade had done better than headlines would indicate. Trade as a share of GDP has only flirted with the 2008 peak ratio so far, remaining slightly below pre-crisis levels through 2018, but that is measured against an expanded GDP figure (see chart 4). Corrected for the decline in commodity fuel and metal prices, however, trade has recovered as a share of global GDP even as GDP has expanded.7 The trade picture may have changed since 2018. The redo of the North American Free Trade Agreement (NAFTA) into a United States – Mexico – Canada Agreement (USMCA) with stricter rules on autos and greater access to the Canadian dairy market looked promising, but still must pass the U.S. congress. The twists and turns in the stock market on rumors about the off-again-on-again U.S.-China trade deal may if anything understate the gap between the two sides, and it seems unwise to bet on an agreement that resolves fundamental differences in the attitudes on trade rules. Do you really want to lend more in this environment? Financial balkanization Economists tend to frown upon any shrinkage in liquidity for markets, or any diminution in the number of choices available. Likewise, balkanization – where markets are only weakly linked – can look bad to economists. For everyone else, highly-interconnected financial markets – especially those connected across international borders without clear lender of last resort facilities – can be scary. Without a doubt the financial system has been balkanized in the last decade. Total cross-border exposure for banks reached a peak of $30.4 trillion at the end of March 2008, just after the closure of Bear Stearns. One year later, as stock markets bottomed, this exposure had shrunk 18%. At the end of 2018 the exposure still posted a cumulative decline of 15% to $25.9 trillion from the peak (see Chart 5), even as economic activity has expanded in most parts of the globe. Through the end of 2009 there was surprisingly little differentiation between borrowers, and what differentiation there was looks strange in retrospect. Claims on Italy and Spain shrank in line with the average, those on the United States and France fell somewhat more than the average fall of 14%. Japan stood out as noticeably better with a shrinkage of only 6%, though cross-border bank credit to Portugal

6 Ireland made a major upward adjustment to GDP calculations beginning in 2015, but even without the adjustment had already exceeded pre-crisis levels of real GDP in 2014. Portugal’s real GDP in 2018 was less than 1% higher than the pre-crisis peak in 2008, not exactly a stellar achievement. 7 One side effect of the shale boom in the United States is to reduce sharply U.S. imports of fuels; U.S. exports of fuels remain tiny. U.S. imports of fuels were an important portion of global volumes.

had shrunk even less. With the benefit of hindsight, the surprise is that among the PIIGS only Greece and Ireland experienced a contraction worse than the global average. Exposures to emerging markets held up better, with no declines for major Asian emerging markets or for BICS (the R for Russia is missing for a reason – exposure to Russia fell roughly in line with Greece and Ireland through the end of 2009). From 2010 on, the connectivity of winners – as measured by borrowings from global banks covered in the Bank for International Settlements (BIS) survey – recovered. For losers it diminished further, even as total cross-border exposures remained relatively constant. Greece has fared worst, sustaining an 89% contraction since March 2008 in the amount that it borrows across borders. Of course, that included the large write-off of bank claims on the sovereign. So far banks have shown no interest in rebuilding that business. As borrowers, the PIIGS in general have only 43% of the banking connectivity that existed a decade ago, and the best performer – Portugal – has only 58% of the connectivity at the peak. The United Kingdom, whose borrowings are only 57% of what they were when the crisis started, has suffered most among larger developed nations. This loss may have been exacerbated by Brexit, but it was mostly in place before the vote (at this writing, Brexit has yet to happen). Japan is the only major developed country that has seen its borrowings expand, though Switzerland comes close at 98%. The United States has recovered to 91%, not so bad until one remembers that Belgium has recovered almost the same amount. Obviously, there were a few “winners,” given that the total fell only 15%. Among borrowers of size, the winners are in Asia. Cross-border loans to China rose 244%. Thailand followed with a rise of 186%, then Indonesia at 155%. Talk of Asian winners provides echoes of the late 1990s. Europe’s role in cross-border lending has diminished even more than its role in borrowing. Ireland was the biggest casualty, with lending falling 88%, followed by Belgium, a small but “core” European banking nation which lost several banks in the crisis. But the biggest banking powers in Europe – the United Kingdom, Germany, France, and Switzerland – have also seen their roles diminish, around 60% in the cases of both Germany and Switzerland (see Chart 6). The one surprise might be the 39% expansion of Spanish banks in cross-border lending, as those institutions have been consolidating their role in a number of markets despite the crisis. The role of Japanese and U.S. banks in cross-border financing has risen (see Chart 6) by 81% and 95% respective, yet both are pikers compared to Canadian banks, whose cross-border lending has risen 131%, driving the other category.8 Bank-to-bank connectivity has shrunk even more dramatically. Bank lending across borders to other banks has fallen from 28% of all exposures to just under 14% by the end of 2018 (see Chart 7), even as total claims have fallen. This outcome may not trouble most regulators and other observers of the crisis. If the share of all lending to banks has fallen, then someone’s share must have risen – in this case, the official sector and the nonbank financial sectors (see Chart 7). Expansive macroeconomic policies and the need to bail out several banking systems may have made the expansion in lending to official borrowers unavoidable for the first 5 years, and the subsequent shrinkage in claims on the official sector is mostly explained by the fall in claims on Greece. The dramatic expansion in cross-border claims on nonbank financials is one manifestation of the growth in shadow banking. This outcome is presumably unintentional, given the amount of ink devoted to the evils of shadow banking. Credit to this sector (which has only been reported separately since 2013) has more than tripled in absolute terms over the last five years; in relative terms, it went from less than half the size of lending to banks to about 33% higher

8 The BIS data do not incorporate information from potential “rising” financial nations such as China. Taiwan, Brazil, Mexico, and Chile are included in addition to the more usual Anglo, European, and Japanese sources.

than lending to banks. These numbers apply only to cross-border lending, so would not cover domestic lending to shadow banking institutions, which has been the focus in China, for example. Also presumably unintentional was the fall in share and amounts of lending to private nonfinancial borrowers. Still, a contraction also took place during the resolution of Japan’s banking crisis, as corporates tried to rebuild their balance sheet through cost cutting and cash retention. Finally, cross-border off-balance sheets items, such as derivatives, lines of credit, or guarantees, have fallen substantially since the crisis (see Chart 8). The fall in derivatives has been a more recent development, the fall in credit lines and guarantees dates back to the start of this decade. Most regulators have probably welcomed this outcome. Balkanization has happened in cross-border markets over the last decade, but is balkanization bad? It seems to have directed credit away from some of the appalling (with the possible exception of that sharp rise in shadow banking), though of course it is the appalling that most need support. Good or bad, balkanization may prevail for some time. Most of these outcomes seem pretty sensible. Do you really want to lend more across borders in this environment? And do you really want to lend more to shadow banks? Too much debt – the cases of Japan and the United States The private sector in many nations had also loaded up on debt before the crisis. Some improvements have occurred in the decade since. The United States was very much in need of adjustment, and a noticeable amount has occurred in the last ten years. Household debt as a share of GDP in the United States has slipped 24 percentage points since the peak, and financial sector debt by a whopping 44 percentage points (see Chart 9). Within the household sector, the share of GDP dedicated to mortgages has dropped 25 percentage points through June 2019. In aggregate the other forms of household credit have expanded in line with GDP, although the portion devoted to student loans has risen by 3 percentage points. After a 3-year dip, credit to the nonfinancial business sector has recovered to pre-crisis levels. An expansion of government debt has offset about half the decline in other sectors. The Japanese situation offers an interesting contrast. Japan’s market peak occurred on the last day of 1989, and the subsequent 15 years were spent in discussions about the dire situation of Japanese banks and a number of zombie corporations, though with only slow efforts at reconstructing the capital of Japanese banks prior to 2005. The global financial meltdown precipitated further capital raisings by the major Japanese banks in 2009. But debt problems in the household and nonfinancial corporate sectors were the exception rather than the rule when the 2008 crisis hit; debt to GDP ratios in those sectors were low in 2008 and have stayed low in the intervening decade (see Chart 10). What has happened is a curious rise in the debt to GDP ratio of private financial institutions, which have essentially been offering expanded deposit services without any real outlet for those deposits. Even investing in government bonds has been well-nigh impossible, as the QQE policy of the Bank of Japan has brought that institution to the point that it holds almost 50% of government bonds. At first glance Japan seems to be in much the worse situation on public sector debt. Large fiscal deficits at the federal level have driven up the debt to GDP ratio for the U.S. public sector, but the gross figure

remains below 140% (see chart 11). Japan’s ratio, on the other hand, has ratcheted up several times in recent decades. For now it has stabilitzed in the 230% to 235% range as net new issuance declined, high yielding bonds were replaced with low (virtually “no”) yielding JGBs, and the nominal value of GDP slowly expanded. As a practical matter the two may be at roughly the same debt level; forex reserves offset around 100 percentage points of the figure for Japan, while they do not improve the U.S. figure by very much. No matter what corrections one might make, both countries exceed the 90% debt to GDP ratio that Reinhart and Rogoff cited as a point that, once exceeded, growth prospects would be damaged. Too much debt – Europe Many European nations had too much debt when the crisis broke, but those stories have evolved in very different ways. Several of the PIIGS countries faced the problem of the “doom loop:” the problems of a nation’s banks pressure the fiscal situation of the home country; the deterioration in the home country’s fiscal posture in turn weakens the banks holding its bonds, which are typically home country banks. Finding a loan then can be tough, as country risk and bank risk premia rise, let alone the likely rise in borrower-specific risk in such a macroeconomic environment. Bank rescues and macroeconomic packages drove up government debt as a share of GDP (see Chart 11). The Maastricht criteria limiting the debt to GDP ratio at 60% in eurozone member countries has largely become an historical curiosity outside of Luxemburg, though Germany and the Netherlands are slowly working back to that level. Switzerland and a number of smaller European countries (such as Denmark and the Baltic nations) never crossed that threshold (but most are not euro members, so are not bound by the criteria). Great Britain and France are in a league with the United States, with a ratio close to or above 120%; Italy and Portugal, flirting with or above 150% ratios; and Greece, approaching 200% again despite defaulting on major chunks of debt. All these exceed the 90% debt to GDP ratio that Reinhart and Rogoff cited as a point that, once exceeded, growth prospects would be damaged. A variety of problems were found with the exact calculation and the lack of hesitation in asserting so specific (and low) a ratio.9 Still, the growth problems that exist for Greece and Italy in 2019, ten years after the meltdown, suggest that while 90% might not be the trigger point, danger lurks at a ratio that is not too much higher.10 Once emergency financial measures were concluded in Europe (including packages with the International Monetary Fund), most of the governments engaged in quantitative easings. In the eurozone those policies were coordinated by the European Central Bank (ECB), not individual central banks. During the process the ECB made available long-term refinancing operations (LTROs) in 2014 and 2016. The latter set of operations involved targeted LTROs (T-LTROs) that extended credit to private banks on favorable terms provided that banks increased lending. The T-LTROs mature in 2020 and 2021, and the ECB has promised to renew those operations to renew those operations, which were especially useful for Spanish and Italian banks.11 Banks needed a new program by September 2019, since the funds disappear from net

9 For some of these issues from a very nonfinancial source, see John Cassidy, “The Reinhart and Rogoff Controversy: A Summing Up,” The New Yorker, April 26, 2013. 10 The arguments against austerity can be seen in Mark Blyth, “Austerity: The History of a Dangerous Idea,” Oxford University Press, 2012. 11 Joseph Wallace and Pat Minczeski, “Markets warm to the prospect of an ECB funding boost for banks,” Wall Street Journal, February 20, 2019. The headline reference to a boost may be inaccurate, since the issue seems to be more the renewal of the old credits rather than an expansion.

stable funding ratio (NSFR) calculations when they have less than a year to maturity. In July 2019 the ECB announced the conditions for T-LTRO III, which commences in September 2019.12 Too much debt – emerging markets Lending has already expanded sharply in some parts of the developed world over the last decade, but one has to wonder about any new opportunities. A 2018 study from the Center for Global Development identified eight countries at risk.13 One of those, Pakistan, has since entered renegotiations. Sri Lanka turned over a port complex to China when it couldn’t repay, Kenya has been arguing about corruption in the railroad built by Chinese construction companies. China earlier had already been identified as having the highest rate of growth in cross-border borrowing among major countries, usually a cautionary sign even if the U.S.-China trade dispute were to calm down. Venezuela cannot pay back what it borrowed from Russia and China, Argentina just went into default yet again, and Mozambique got caught up in $1 billion worth of loans and corruption on tuna boats. Which border were you hurrying to cross? Home country considerations constrain some banks from getting bigger In some countries the largest several banks have assets that exceed the size of the economy and the resources of the central bank, and thus those banks may pose a major risk to the sovereign. The Swiss authorities took measures more extreme than the revised Bank for International Settlements (BIS) capital standards to address this issue, but still “lead” the pack on this measure of risk – the top two banks account hold assets equivalent to over 320% of GDP (see Chart 12). France, Australia, and the United Kingdom have ratios in excess of 200%. Canada’s positioning toward the top of the list with a ratio of 185% might seem to diminish the usefulness of this statistic, since Canada has largely avoided banking crises.14 But it is worth bearing in mind that Canada showed the fastest growth among major developed countries in its cross-border lending over the last decade, and rapid asset growth can be a sign of problems to come. The United States also contradicts any easy conclusions. The top six banks in the United States hold assets equivalent to barely 50% of GDP in 2016, yet the United States has frequently had sizable banking crises. This has sometimes been attributed to political factors trumping the economic in the design of the American banking system.15 Whether one can find causation or even correlation in the data is not agreed, but several countries have clearly taken the statistic to heart and supported higher capital standards for their banks lest this indeed become an issue. This is not purely an issue of cross-border lending, but if balance sheets need further shrinkage, presumably both domestic and cross-border lending may still come down. Who is going to do this cross-border lending?

12 European Central Bank, “Decision 2019/XX* of the European Central Bank of 22 July 2019 on a third series of targeted long-term refinancing operations.” 13 John Hurley, Scott Morris, and Gailyn Portelance, “Examining the Debt Implications of the Belt and Road Initiative from a Policy Perspective,” CGD Policy Paper 121, March 4, 2018. 14 Charles W. Calomiris and Stephen Haber, “Fragile by Design: The Political Origins of Banking Crises and Scarce Credit,” Princeton University Press, 2014. 15 Ibid.

Other issues – regulatory/monetary policy Resolution of a variety of regulatory issues might make it easier to improve, perhaps also expand, cross-border bank lending. One issue that needs to be resolved is the procyclicality that can result from policy. As bank profitability recovers in the middle stages of an economic recovery, capital again starts to build up and banks presumably look for avenues by which to invest this capital. Conversely, when loans go bad and write offs begin, banks are short on capital to resume lending. Various organizations, including the U.S. Federal Reserve and the BIS, have thus moved for countercyclical capital buffers to smooth these tendencies.16 The U.S. Federal Reserve might say that it has implemented these rules, but that is a matter of definition given that the buffer is set at 0%. The Fed has proposed to make changes in the calculation of capital in the annual stress tests which are said to make the testing less pro-cyclical by not subtracting dividends consistent with recent payout rates in the stress tests.17 By allowing for changes in dividend policy as banks presumably move from high dividends (end of cycle) to lower dividends (recession cleanup), it becomes easier to pass stress tests without new capital raises, presumably making banks willing to lend more money, whether at home or across borders. But that is true without changing the 0% rate at which the buffer is currently set, perhaps to make a future setting of the buffer above 0% more palatable. There have also been arguments that the interest paid on reserves by the Federal Reserve makes lending less attractive, especially when the economy is weak. In other words, excess reserves are an asset almost as safe as Treasury bills if not as safe. Yet in weak economic times excess reserves might pay higher on a risk-adjusted basis than new loans, offering an alternative to lending and perhaps exacerbate a credit crunch. We might have a chance to see this experiment play out in the near future. It is too early to tell whether the event merely constitutes noise or a fundamental problem, but in mid-September there was a sudden spike in the Federal Funds rate. This ultimately required the Fed to provide extra overnight funding to the market for several days running, and then to propose two-week financing to bridge the end of the September quarter.18 The Fed’s reduction in its bond portfolio has been cited as a possible cause of the problem, but this seems too facile given that the Fed’s bond portfolio, whether Treasuries or mortgages, is many times the size that it was in the early 2000s. But should there be volatility in such an anchor financial instrument, cross-border lending may well be a victim. Cross-border lending to poorer countries has also diminished on concerns about money laundering, or at least about the adequacy of local controls to preclude money laundering. Clearly if authorities ease up here, banks may well lend more, particularly toward re-establishing lines of credit with local banks for remittances. This is clearly not a purely financial question, but one driven by national or global security considerations. It might be better if banks could handle more business in this area, rather than allow an unregulated nonbank competitor – such as Blockchain based systems – to execute these transactions.

16 Basel Committee on Bank Supervision, “Consultative Document: Countercyclical Capital Buffer Proposal,” July 2010 (but released for comment September 10, 2010); Board of Governors of the Federal Reserve System, “Federal Reserve Board approves final policy statement detailing framework for setting Countercyclical Capital Buffer,” press release, September 8, 2016. 17 Lalita Clozel, “Fed’s Quarles floats new tool to combat credit crunches,” Wall Street Journal, September 5, 2019. 18 Nick Timiraos and Daniel Kruger, “Fed intervenes to curb soaring short-term borrowing costs,” Wall Street Journal, September 17, 2019; Adam Samson and Joe Rennison, “Federal Reserve announces new effort to soothe money markets,” Financial Times, September 20, 2019.

Other issues – pricing Among the scandals exposed in the 2007-09 global financial crisis brought the London Interbank Borrowing Rate (LIBOR). It had long been the custom to call up banks to see what the pricing was for this rate; that data, collected by the Bank of England, was ultimately published and used in both loan contracts and a variety of other contracts, such as derivatives. When markets seized up in 2008, some of the major banks that provided daily info on LIBOR came up with numbers to report in a market that essentially had no trades. One consequence was that banks had to pay roughly $10 billion to settle cases involving LIBOR manipulation.19 Another consequence was a search for a substitute for LIBOR in contracts, whose use is scheduled to end in 2021. Despite the efforts, the evolution to a new standard has been slow. Banks and regulators have officially settled on a replacement created by the U.S. Federal Reserve, known as the secured overnight financial rate (SOFR). But the replacement is untested, and LIBOR still dominates SOFR in recent floating-rate debt issues.20 The Financial Standards Accounting Board has tentatively decided that contracts that switch reference rate (e.g., LIBOR to SOFR) won’t need to go through evaluation processes that can be costly, though the final ruling only needs to be implemented by 2021, when LIBOR comes to an end.21 And the euro faces issues still in the switch from the Eonia benchmark to the new €STR, scheduled to take effect in October 2019.22 Progress in the switch from LIBOR to SOFR needs to be watched (perhaps sustained is the better word) as one part of making cross-border lending easier. Other issues – funding One other problem during the financial crisis a decade ago was that non-American banks had difficulty finding the dollars to fund their lending operations across borders. A substantial portion of the liquidity provided in the immediate aftermath of the crisis went to foreign banks sourcing dollars in the United States and funneling them to the parent headquartered outside the United States. Japanese banks in particular were considered to be subject to paying a premium above and beyond that of other non-U.S. banks with comparable risk profiles, dating back to the slow restructuring of Japanese banks in the 1990s and early 2000s. Some changes have occurred in funding patterns. In particular, the European banks seem to be less dependent upon dollars sourced in the United States.23 Japanese banks seem still to be subject to higher borrowing costs versus European competitors of comparable risk, though this might be a result of the increased funding needs of Japanese banks as they take share from European competitors.

19 David Enrich, “Libor: A Eulogy for the world’s most important number,” Wall Street Journal, July 27, 2017. 20 Daniel Kruger, “Companies slow to move away from Libor,” Wall Street Journal, September 15, 2019. 21 Tatyana Shumsky, “FASB advances toward easing accounting burden for Libor phaseout,” Wall Street Journal, June 19, 2019. 22 Martin Arnold and Philip Stafford, “Europe’s banks warned on ending interest rate benchmark,” Financial Times, August 19, 2019. 23 Iñaki Aldosoro, Torsten Ehlers, and Egemen Eren, “Global Banks, Dollar Funding, and Regulation,” BIS Working Paper no. 708, revised May 2019.

Still, the issues remain. Given that most cross-border funding is in dollars, it is far from clear that all the mechanisms are in place to guarantee that dollar funding will be there when necessary. The euro remains a relatively strong currency, but it is not clear that any mechanism is in place to provide extra euro funding to support cross border lending (the most recent measures seem designed more to support lending by local banks within local borders using the euro). And the renminbi is not close to taking on any such role in commercial lending, given its participation in only 4.3% of foreign exchange trades.24 Other issues – profitability Bank profitability recovered in most markets, but not always to pre-crisis levels. Even in the United States, whose big banks have done best against their peers, the evidence is contradictory. The results for the first half of 2019 generated contradictory headlines about U.S. banks taking over the world yet also seeing sharply diminished profits, though admittedly in investment banking rather than lending operations.25 Few big banks outside the United States have had to worry about contradictory evidence, simply because almost all of the news is unwelcome. It is tough to earn a spread in countries with negative interest rate policies (Japan, Switzerland, Scandinavia, and all of the eurozone); it is tough to earn a spread in countries with weak economies (most, but especially the eurozone). Japan’s megabanks have operations in the United States and Asia that have carried them through, but regional banks have been forced to invest in overseas securities to try to offset stagnation and low margins at home. In closing: should one a (cross-border) lender or borrower be? English majors at many major American universities no longer have to take a course in Shakespeare to get their degree. Perhaps they will be replaced by budding lawyers, regulators, and economists searching Shakespeare’s plays for wisdom and policy solutions. Many improvements on the macroeconomic, profitability, and regulatory fronts will be needed to give banks an incentive to pursue the right sort of cross border lending; many improvements on the macroeconomic front will be needed to make more of the cross-border borrowers attractive. And with an aging economic recovery (even if recoveries do not die of old age), many will indeed worry that lending may indeed cause amnesia in borrowers if payments come due during a recession. At the least, if you will a lender be, be careful when you lend more across borders.

24 James T. Areddy, “China is pitting the yuan against the dollar. So far, it’s not going to plan,” Wall Street Journal, September 16, 2019. 25 Liz Hoffman and Telis Demos, “How U.S. banks took over the world,” Wall Street Journal, September 4, 2019; Steve Morris and Laura Noonan, “Investment banking revenues plunge to 13-year low,” Financial Times, September 4, 2019.

Chart 1

Source: Bank of Japan, St Louis Federal Reserve, Bank of England, ECB; author’s calculations Chart 2

Source: OECD, author’s calculations. PIIGS (Portugal, Ireland, Italy, Greece, Spain) adjusted for Ireland GDP revision beginning 2015.

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Source: BIS, author’s calculations. This measure only encompasses claims on banks books, on an ultimate lender basis, and is identified by borrower’s nationality. Asian EMs are India, China, Thailand, Malaysia, and Indonesia; non Asian EMs are Brazil, Mexico, South Africa, and Turkey. Chart 6

Source: BIS, author’s calculations. Big 4 consists of Germany, France, Switzerland, and the UK.

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Source: BIS, author’s calculations. Nonbank financial is a subsector within nonbank private, but data are not available for 2008Q1. Chart 8

Source: BIS, author’s calculations. Share of cross border balance sheet lending only.

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Source: U.S Federal Reserve Chart 10

Source: Bank of Japan

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Source: OECD, author’s calculations. Chart 12

Source: GDP data from OECD, author’s calculations using annual reports of top banks. The number after a country name indicates how many banks are included in the calculation.

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