Foreign Funded Credit: Funding the Credit Cycle?

Abstract

This study investigates what drives the credit cycle, focusing on the role of foreign funded bank credit (FFC). Considering credit cycles in 41 countries over the period 1985-2015, this study finds that credit booms are associated with an increase in the share of FFC in an economy, both in emerging and developed economies and for business as well as for household credit cycles. The impact of FFC on credit booms is however significantly higher in emerging countries. While FFC increases rapidly during the boom, the period preceding the boom is characterized by an in increase in domestically funded credit relative to FFC. FFC thus accelerates credit during the boom. The increased credit needs during a boom may cause the subsitution of domestically funded credit by FFC, as the growth in FFC is less restricted than domestically funded credit, for example by the domestic deposit base.

Keywords: credit cycles, international banking, financial crisis

JEL Classification: F34, F44, G21