Multinational banking: The crisis and its policy response

Stylized data shows a structural break in the integration of lending markets which coincides with the global financial crisis. During and after the crisis, banks actively reduced their share of foreign relative to domestic banking activity and lending in particular. This increase in lending "home bias", which is thought to have been driven by a reduction of overall loanable funds, has curiously persisted throughout the recovery stage of the crisis and consequent policy interventions. We propose a simple theoretical framework to retrace the decision making of multinational banks in a changing regulatory and financial environment. We show that regulatory and monetary policy measures, as enacted after the crisis, have a differential effect on the profitability of banks' domestic and foreign lending operations. Due to lower inherent information costs, banks' domestic lending operations become disproportionally safer and more profitable following a tightening of equity requirements and loosening of monetary policy. This quantitative difference leads to an increase in the share of banks' domestic lending in total lending.