Banking Complexity in the Global Economy

Abstract

International lending flows are often intermediated through banking hubs and complex multi-national routing. We develop a dynamic stochastic general equilibrium model where global banks choose the path of direct or indirect lending through partner institutions in multiple countries. We show how conflating locational loan flows with ultimate lending causes bias in the results both by attributing ultimate lending to banking hubs, and by missing ultimate lending that occurs indirectly via third countries. We then study the effects of global banking complexity, the aggregate degree of indirect credit allocation, e.g. via affiliates, subsidiaries or complex financial arrangements. Indirect lending allows countries to bypass shocked lending routes via alternative countries; however, it dilutes their ability to diversify sources of funds following shocks. The quantitative analysis reveals that banking complexity can exacerbate credit instability when countries feature heterogeneous banking relative efficiency.

Keywords: indirect lending, banks, locational loan flows, financial integration

JEL Classification: F36, F40, G20