Bankers without Borders

Jan Schildbach, a banking analyst at Deutsche Bank Research

FRANKFURT – At the height of the financial crisis in 2008-2009, it seemed as if Western banks would pull up their foreign stakes and go home, leaving financial markets much more fragmented along national lines. But, as a new report by Deutsche Bank Research shows, banks’ cross-border business – direct or via branches or subsidiaries – has now broadly stabilized.

During the crisis, the level of banking activity fell particularly strongly in capital-intensive areas such as traditional lending to the private sector. The effect was especially pronounced in lending to non-financial companies, whereas lending to households – an area with traditionally lower internationalization – remained more robust.

In part, the decline was due to increased holdings of foreign public debt relative to private debt. Prior to the crisis, banks had often been net sellers of foreign government bonds, but they significantly increased their purchases during 2008-2009. With the onset of the European sovereign-debt crisis in 2010, banks’ appetite for public debt fell again.

In contrast to lending activities, banks’ commitment to foreign markets has remained virtually unaffected with respect to purely intermediary activities such as investment banking and asset management. Interbank relationships, as well as investment-banking operations, are already highly international. The deep cross-border links between financial institutions and the activity of globally active investment banks only took a brief hit from the crisis. By contrast, the importance of foreign markets for asset managers remains very limited and has not changed significantly since 2007.

Despite the recent setback, banks’ presence in foreign markets today is much greater overall than it was a few years ago. One reason is that revenue growth usually goes hand-in-hand with macroeconomic growth, which increasingly is found in emerging-market countries, rather than in many banks’ mature Western home markets. Moreover, private and public-sector debt levels tend to be much lower in the emerging economies.

At the same time, geographically diversified institutions outperformed even during the recent global crisis, because they were less vulnerable to downturns in individual regions. And, at least until a certain stage of growth, economies of scale and scope beckon, with expansion abroad often the only way to increase size, given already-saturated domestic markets.

Of course, integrated financial markets also benefit banks’ clients by enabling institutions to provide broader and higher-quality financial services at lower prices. Furthermore, strong international financial partners are indispensable to multinational corporations, which often need global cash management or support for large-scale transactions.

Given these advantages, the pace of internationalization has been swift. As recently as 2001, Europe’s top 20 banks still generated more than half of their revenues at home. By 2010, this share had fallen by 10 percentage points, to 42% – a remarkable decline that was interrupted only briefly by the financial crisis.

Interestingly, most large European banks’ prime investment destination was other European markets, not other parts of the world, raising Europe’s contribution to total revenue to nearly 30%, from less than 20% a decade ago. There may be two explanations for this: for one thing, Asia’s share in European banks’ revenues has probably risen. But this may have been offset by a decline in the proportion of earnings coming from the US. And, while this reflects changes in relative importance, European banks’ business volumes might have increased in absolute terms even in the US, though at a slower pace than elsewhere.

Overall, the outlook for post-crisis international banking has turned positive. But regulation could change that. In the current environment, with a renewed focus on regulating markets, institutions, and financial instruments, some international differences in scale, scope, and application of the new rules may be inevitable. But, without a broadly consistent approach, the authorities risk creating a legal patchwork that would make cross-border banking less efficient, more expensive, and more difficult to conduct.

Apart from discouraging banks from investing abroad, outright restrictions on foreign banks’ market access cannot be ruled out, either. The rapid growth in intra-European banking relations in the past decade was made possible to a large extent by the abolition of formal and informal barriers to foreign service providers. Though this environment may not be fundamentally at risk, the current trend towards increasing capital requirements for international banks – reflected, for example, in calls for the establishment of independent subsidiaries with autonomous capital and liquidity pools – is clearly worrisome.

Nonetheless, given the relatively favorable outlook for cross-border banking, Western banks’ presence in emerging markets could strengthen further, while banks domiciled in these regions might start looking beyond national borders. Traditional lending and deposit-taking still offers much growth potential – and may become more attractive relative to investment banking or asset management as a result of new regulation. In that case, banking will become more like other industries that have benefited themselves and their customers by evolving into truly global networks.

Post-Crisis World Institute