Working Paper: CEPR ID: DP16606
Authors: Natacha Postel-Vinay; Stphanie Collet
Abstract: What is the impact of hot capital inflows on bank risk-taking? In an increasingly financially globalised world this question becomes especially relevant. However few authors have examined it in detail empirically, despite repeated crises in Latin America, East Asia and the Eurozone from the 1980s to the 2010s. In this paper, we collect individual bank data on one of history’s most striking examples of a “supply push” in foreign funds: the great inflow of capital from the developed world to Germany in the second half of the 1920s. Bank by bank we examine its effects on decisions related to leverage, lending and liquidity. The specificities of the time period – the Dawes Plan of 1924 as well as the relative absence of a Too-Big-to-Fail environment, which we document through extensive historiographical analysis – allow us to mitigate endogeneity concerns. We develop a three-step approach in which we run panel regressions including only months of falling interest-rate spreads, and apply a two-stage least-squares model in which initial bank size is used as an instrument. In all our models our results tend to converge: while capital inflows did not seem to impact banks’ liquidity decisions, their impact on leverage was non-negligeable. This paper’s results thus call for extra prudential oversight whenever cross-border banking flows increase significantly.
Keywords: money supply; credit; financial globalization; foreign debt; international lending; financial development; financial crisis
JEL Codes: E51; F34; F65; G21; N24; N14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| leverage (G24) | riskier lending practices (G21) |
| initial bank size (G21) | hot capital inflows (F32) |
| hot capital inflows (F32) | bank health (G21) |
| bank risktaking (G21) | liquidity (E41) |
| hot capital inflows (F32) | bank risktaking (G21) |
| hot capital inflows (F32) | leverage (G24) |
| initial bank size (G21) | leverage (G24) |