Financial Development and the Effect of Cross-Border Bank Flows on House Prices

Abstract

We analyse the role of financial development as a buffer to diminish the effect of a cross-border bank flows shock on house prices. From panel vector auto-regressions, we compute impulse-response functions for 38 countries ranked and grouped by financial development. In less financially developed countries, the observed response is positive and significant. As the level of development increases the response is tempered and becomes insignificant. Our findings extend to equity and bond markets. Cross-border bank flows shocks are also more important in explaining the historical dynamics of house prices in comparison to other shocks of a domestic nature in financially less developed countries while monetary policy shocks are key in the most financially developed markets. We explore the heterogeneity in house price response within each level of financial development, differences are associated with the levels of maximum loan-to-value ratios and a ratio of cross-border bank inflows over total liabilities abroad.

Keywords: Cross-Border Bank Flows, House Prices, Financial Development, Historical Decomposition

JEL Classification: C32, E44, G15