The macro-financial effects of international bank lending on emerging markets

Abstract

We provide novel empirical evidence on the effects of cross-border bank lending on emerging market economies' (EMEs) macro-financial conditions. We identify causal effects by leveraging the heterogeneity in the size distribution of bilateral cross-border bank lending to construct granular instrumental variables for aggregate cross-border bank lending to 22 EMEs. Cross-border bank credit causes higher domestic activity in EMEs and looser financial conditions. Financial condition indices ease, nominal and real effective exchange rates appreciate, sovereign and corporate spreads narrow, domestic interest rates fall, and housing prices increase. Similarly, real domestic credit grows, real GDP expands, and imports rise. Using a simple model, we motivate our instrument and show how commonly used instruments that correlate with global financial conditions (e.g. the global financial cycle) can yield biased estimates. We find empirical evidence of an amplification bias, which is consistent with the prominent role of global risk perceptions and international risk spillovers.