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Impact of foreign banks on the economy in the presence of sovereign stress

Summary:
Ugo Albertazzi, Jacopo Cimadomo and Nicolò Maffei-Faccioli in this ECB paper: This paper explores whether foreign intermediaries stabilise or destabilise lending to the real economy in the presence of sovereign stress in the domestic economy and abroad. Tensions in the government debt market may lead to serious disruptions in the provision of lending (i.e., the so-called “doom loop”). In this context, the presence of foreign banks poses a fundamental, yet unexplored, trade-off. On the one hand, domestic sovereign shocks are broadly inconsequential for the lending capacity of foreign banks, given that their funding conditions are not hampered by such shocks. On the other, these intermediaries may react more harshly than domestic banks to a deterioration in local loan risk and demand

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Ugo Albertazzi, Jacopo Cimadomo and Nicolò Maffei-Faccioli in this ECB paper:

This paper explores whether foreign intermediaries stabilise or destabilise lending to the real economy in the presence of sovereign stress in the domestic economy and abroad. Tensions in the government debt market may lead to serious disruptions in the provision of lending (i.e., the so-called “doom loop”).

In this context, the presence of foreign banks poses a fundamental, yet unexplored, trade-off. On the one hand, domestic sovereign shocks are broadly inconsequential for the lending capacity of foreign banks, given that their funding conditions are not hampered by such shocks. On the other, these intermediaries may react more harshly than domestic banks to a deterioration in local loan risk and demand conditions.

We exploit granular and confidential data on euro area banks operating in different countries to assess this trade-off. Overall, the presence of foreign lenders is found to stabilise lending, thus mitigating the doom loop.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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