Risk Sharing and Amplification in the Global Banking Network 
During times of financial stress, banks can transmit and amplify shocks to other banks and firms around the world, reducing the availability of credit in the global interbank and corporate lending markets. They also can engage in risk sharing by increasing their supply of credit to countries experiencing shocks. This paper analyzes the role of global banking linkages in sharing risk and amplifying shocks, both across countries and over time. It studies whether banks or firms from some countries receive more credit in response to local shocks or experience greater amplification of foreign shocks. It also looks at how banks’ role has evolved since the Global Financial Crisis (GFC). For their analysis, the authors develop a model of the global banking network that incorporates a global interbank network and a global credit network. The former network captures the bilateral cross-border borrowing and lending relationships that banking sectors form with each other, and the latter captures the lending relationships that banking sectors form with foreign and domestic corporate sectors. The authors estimate the model using a complete set of bilateral lending data for 19 countries and provides time-varying estimates of bilateral and aggregate loan supply elasticities for cross-border interbank and firm lending from 2009 through 2019.
Key Findings
- The elasticity estimates reveal significant heterogeneity in banks’ willingness and capacity to lend to different countries.
- The heterogeneity in banks’ willingness and capacity to lend across countries explains the variations in the extent of both the credit that countries receive in response to local funding shocks and the amplification of foreign funding shocks that countries experience. Countries with lower loan supply elasticities receive less credit in response to local shocks, and countries with creditors that are more willing or have greater capacity to lend to shocked countries experience greater amplification of foreign funding shocks.
- Risk sharing in the global banking network has declined significantly since the GFC, with countries now receiving less credit when they experience local funding shocks.
- The degree of shock amplification has also declined on average since the GFC, but some countries may experience greater amplification of foreign funding shocks.
Implications
The authors’ results reveal significant changes in the global banking network over the past decade that affect the vulnerability of banks and firms to domestic and foreign funding shocks, which in turn could have important implications for financial stability and the real economy. They provide evidence that suggests stricter regulations have contributed to the decline in cross-border loan supply elasticities.
Abstract
We develop a structural model of the global banking network and analyze its role in facilitating risk sharing and amplifying shocks across countries and over time. Using bilateral international lending data, we uncover significant heterogeneity in the willingness and capacity of banks to provide cross-border interbank and corporate loans. This heterogeneity explains variation in risk sharing and amplification across countries. Moreover, we show that cross-border loan supply has become less elastic over time, resulting in a decline in risk sharing. While shock amplification has also declined on average, some countries may experience greater amplification in response to foreign funding shocks.