Cross-Border Lending and the International Transmisson of Banking Crises

Abstract

This paper introduces a new transmission channel of banking crises where sizable cross- border bank claims on foreign countries with high domestic crisis risk enable contagion to the home economy. This asset-side channel opposes traditional views that see bank- ing crises originating from either domestic credit booms or from cross-border borrowing. I propose a combined model that predicts banking crises using both domestic and for- eign factors. For developed economies, the channel is predictive of crises irrespective of other types of capital ows, while it is entirely inactive for emerging economies. I show that policy makers can significantly enhance current early warning models by incorporating exposure-based risk from cross-border lending.

Keywords: Cross-border bank lending, banking crises, systemic risk, financial linkages

JEL Classification: C53, E44, F34, G01, G21