International Diversification Gains and Home Bias in Banking

30 Pages Posted: 25 Jan 2008

See all articles by Alicia García-Herrero

Alicia García-Herrero

Bruegel; Hong Kong University of Science & Technology (HKUST) - HKUST Institute for Emerging Market Studies (IEMS); Natixis

Francisco Vazquez

International Monetary Fund

Date Written: November 1, 2007

Abstract

This paper assembles a bank-level dataset covering the operations of 38 international banks from eight industrial countries and their subsidiaries overseas during 1995-2004, and studies the extent of diversification gains from their local operations abroad. The paper finds that international banks with a larger share of assets allocated to foreign subsidiaries, particularly to those located in emerging market countries, are able to attain higher risk-adjusted returns. These gains are somewhat reduced - but by no means depleted - when international banks concentrate their subsidiaries in specific geographical regions. The paper also finds a substantial home bias in the international allocation of bank assets, relative to the results of a mean-variance portfolio optimization model. Overall, international diversification gains in banking appear to be substantial, albeit largely unexploited by current bank expansion strategies. These results suggest that international diversification gains could usefully be considered in the second pillar of Basel II as the first pillar is based only on the idiosyncratic risk of recipient countries.

Keywords: international banking, home bias, portfolio diversification, Basel II

JEL Classification: G11, G21, E44, F40

Suggested Citation

Garcia-Herrero, Alicia and Vazquez, Francisco, International Diversification Gains and Home Bias in Banking (November 1, 2007). IMF Working Paper No. WP/07/281, Available at SSRN: https://ssrn.com/abstract=1086779 or http://dx.doi.org/10.2139/ssrn.1086779

Alicia Garcia-Herrero

Bruegel ( email )

Rue de la Charité 33
B-1210 Brussels Belgium, 1210
Belgium

Hong Kong University of Science & Technology (HKUST) - HKUST Institute for Emerging Market Studies (IEMS) ( email )

IAS 2019, Lo Ka Chung Building,
Lee Shau Kee Campus, HKUST
Clear Water Bay, Kowloon
Hong Kong

Natixis ( email )

France

Francisco Vazquez (Contact Author)

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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